Pre-IPO Convertible Notes: The Discount Can Hide the Dilution

A pre-IPO convertible note is debt that may convert into shares when a defined financing, IPO or other contractual trigger occurs. As outlined in DLA Piper’s convertible-securities analysis, the share count generally equals outstanding principal—and possibly accrued interest—divided by the applicable conversion price. A lower price gives the noteholder more shares and dilutes existing owners more heavily.

The stated discount is only one input. A valuation cap may produce a still lower price, while maturity governs the path if the expected transaction never occurs. A proposed note is therefore not equivalent to completed priced equity: the ownership percentage, share class, conversion date and liquidity may all remain unknown.

What the investor owns before conversion

Before conversion, the investor holds rights under a debt contract, not a fixed percentage of the company. The document should define the principal, interest, maturity date, conversion triggers and securities delivered after conversion. The British Business Bank’s CLN guide lists a financing round or IPO among possible triggers and notes that failure to reach a trigger can leave the debt repayable.

“Pre-IPO” describes the expected stage, not a standard set of legal terms. The note must specify whether the IPO itself triggers conversion, whether a private round must exceed a minimum size and what class of shares the investor receives.

The distinction matters in deal coverage. On September 4, 2026, a Reuters report carried by MarketScreener said Nscale was discussing up to $1.5 billion of convertible notes at a double-digit discount to its IPO price, while the potential investors and investment size could still change. That was a reported proposal, not a completed priced-equity round or IPO.

Discount and cap create competing prices

Suppose new investors pay $2.00 per share and the note has a 20% discount. The discounted conversion price is $1.60. At that price, the same investment buys 25% more shares than it would at $2.00.

A valuation cap requires another calculation. In a simplified example, an $8 million cap divided by 10 million shares in the contractual capitalization denominator produces a cap price of $0.80. If the note gives the investor the more favorable result, $0.80 applies instead of the $1.60 discounted price; the discount and cap are not automatically stacked.

The capitalization definition can materially change that result. Outstanding shares, options, warrants, other convertibles and an option-pool increase may enter the denominator differently. A cap is therefore not a promise of ownership at a simple headline valuation; it must be read alongside the agreed pre-money or post-money denominator.

Three outcomes from the same $1 million note

Consider a simplified note with $1 million principal, 8% annual simple interest, one year elapsed, a 20% discount and an $8 million valuation cap. Assume the cap denominator contains 10 million shares and that principal plus interest converts. The balance is therefore $1.08 million. These scenarios isolate the note conversion and exclude shares sold for new cash.

High-valuation financing

At a $20 million pre-money valuation, the new-round price is $2.00 per share. The discounted price is $1.60, while the cap price is $0.80. The cap controls, producing 1.35 million shares: $1.08 million divided by $0.80.

Down round

At a $6 million pre-money valuation, the new-round price is $0.60. The discounted price is $0.48, below the $0.80 cap price, so the discount controls. The note produces 2.25 million shares. Existing holders are diluted by both those conversion shares and the shares issued to the new investors.

An SEC-filed Form C/A disclosure explains that discounted or capped conversions give noteholders more shares for the same money and that a down round can intensify dilution for existing holders. The filing is an issuer disclosure, not an SEC endorsement. Calculating final ownership still requires the entire post-closing capitalization.

No qualifying event

If no qualifying financing or applicable IPO trigger occurs by maturity, neither illustrative conversion price necessarily applies. The outcome comes from the note’s maturity provisions, which may require repayment, permit conversion under a separate formula, allow an extension or lead to renegotiation. The absence of a trigger does not turn expected future equity into completed equity.

Interest and maturity alter share count and leverage

Interest can increase the balance that converts even though the headline principal remains unchanged. In the example, omitting one year of interest would miss $80,000 of the conversion balance—100,000 shares at the $0.80 cap price or about 166,667 shares at the $0.48 discounted price.

Maturity is economically important because the issuer may face a cash obligation if conversion has not occurred. Whether holders can demand repayment, elect conversion or approve an extension depends on the document. That debt feature also separates a note from a SAFE when comparing a SAFE with a convertible note.

Conversion does not guarantee immediate liquidity. The note and later equity documents may specify when conversion occurs, which security is delivered and whether contractual transfer restrictions or lock-ups apply. A discount to an IPO price therefore does not establish that the resulting shares can be sold at that price.

What the headline amount leaves unresolved

Before a proposed note can be treated as equity funding in a capitalization model, the documents must resolve these questions:

• Trigger: What financing size and security qualify, and does an IPO, sale or other liquidity event use a separate formula?
• Conversion balance: Does principal alone convert, or does the balance include accrued simple or compound interest?
• Price: What are the new-money, discounted and capped prices, and which contractual selection rule applies?
• Denominator: How are options, the reserved pool, warrants and other convertible instruments counted?
• Maturity: What repayment, extension, default or optional-conversion rights apply if the expected event is late or absent?
• Security and liquidity: Which share class, voting and liquidation rights are delivered, and what limits transfer or resale?
• Status: Is the transaction being discussed, has it been signed, or has the money funded and the deal closed?

A pre-IPO note can postpone today’s equity price without postponing its economic consequences. Its dilution becomes visible only when the conversion balance, competing prices, capitalization denominator and no-event terms are modeled together.

Also read:

• Pre-Money vs Post-Money Valuation: Calculate Ownership and Option-Pool Dilution
• SAFE or Convertible Note? Debt Terms Decide the Better Seed Deal
• Pre-Seed or Seed? Use Milestones—not Round Size—to Describe Your Startup