When the $250K came in, the founders were euphoric.

They’d spent six months building. Their pitch deck was tight. They finally found someone who believed in the vision.

The investor wired the money. Everyone shook hands.

One of the founders updated his LinkedIn: “Pre-seed round closed!”

But three months later, when I was brought in to help clean up the financial model before their next raise, I asked the one question that shifted the mood:

“Did you actually issue equity for that money?”

They paused.

“No… I think it was a convertible note? But we haven’t finalized the valuation yet.”

Exactly.

That investor hadn’t bought equity. He’d bought the right to decide what equity to take.. later.

Early-Stage Capital Isn’t Always What It Looks Like

In the startup ecosystem, we talk a lot about raising money. But not enough about what’s actually being sold.

Most first-time founders assume that when someone invests, they’re buying shares - that money equals equity. But in the early stages, that’s rarely the case.

Instead, most investors use convertible instruments: SAFE notes, CCDs, CCPS, or notes - that don’t involve pricing the company right away.

Why? Because setting a valuation at the early stage is both risky and premature.

It’s Almost Impossible to Value a Startup at This Stage

At the seed or pre-seed stage, there’s often no revenue, no unit economics, and no defensible financial model. You may have a great product, but you don’t have enough traction to justify a number that everyone agrees on.

If an investor demands equity upfront, they risk:

Convertibles delay that tension.

They allow both parties to agree on the belief. And of course, postpone the math until there’s more data to work with.

Convertibles Give Investors Downside Protection if Things Go Bad

This is something few founders realize until it’s too late.

If the company folds or winds down, common equity holders are last in line during liquidation.

But convertible notes and preference shares - like CCPS (Compulsorily Convertible Preference Shares), usually rank above common shares in payout order.

That means if there’s anything left on the table:

To an investor, this isn’t just money. It’s risk insurance.

They’re not just betting on your upside. They are protecting their downside.

Equity Is Final. Convertibles Let You “Adjust Later.”

Here’s the other reason investors prefer convertibles: control over timing and pricing.

Issuing equity is a hard commitment. If you raise $250K for 10% today, that valuation is locked in.

But convertibles let the investor delay the real stake until:

With instruments like CCPS, investors can even negotiate the conversion ratio - a lever that lets them increase their equity stake at the time of conversion based on predefined conditions (like discounts, valuation caps, or ratchets).

In short: They invest now, but reserve the right to rewrite their position later (depending on how things unfold!)

The Founders Thought They Still Owned 90%. They Didn’t.

By the time the company raised its next round: $1.2 million at a $6M post-money valuation. The original investor converted their note using a cap and discount clause that effectively gave them 15% of the company.

The founders were shocked. On paper, they had modeled dilution at about 8-9%.

But because they hadn’t modeled the valuation cap, and didn’t account for conversion mechanics, they ended up giving away more than they expected.

This wasn’t malicious. It was structural.. and of course, entirely standard.

The investor wasn’t hiding anything. But the founders hadn’t understood what they were signing.

What Founders Need to Know Before They Celebrate “Closing a Round”

When a convertible instrument is signed:

What you’ve done is create an obligation that will show up (sometimes months or years later) and impact your ownership, control, and leverage during the next round.

That’s not inherently bad.

In fact, convertibles are an efficient, founder-friendly way to raise early capital, if you understand the rules.

But the key is knowing this:

You didn’t sell shares. You sold the option to buy shares later, often on terms you won’t fully control.

The Deal You Signed Today Is the Equity You Give Tomorrow

The biggest mistake I see is founders treating convertibles as “not real dilution.”

They think:

“It’s just a note. We’ll worry about it later.”

But later always comes. And it usually arrives when you’re negotiating your next round - with very little room to fix the past.

Understand what you’re signing. Model the conversion impact now. And if you’re not sure - get someone who is.

Because investors aren’t playing games. They’re just playing longer and smarter than most founders realize.

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About the Author

Kishore Dasaka is a Chartered Accountant and Fractional CFO who has worked with over 250 founders across the world. He helps early- and growth-stage companies raise capital, avoid hidden dilution traps, and build financial clarity before it’s too late.

Learn more at https://kishoredasaka.com