Agree on the denominator.
“Fully diluted” ownership depends on the agreed capitalization definition. Understand how outstanding shares, options, reserves, and convertible instruments enter the calculation.
Learn / Deal Terms Explained
Follow the terms.
Understand the outcome.
Connect the instrument, ownership, distribution of proceeds, and investor rights. Worked examples make the relationships easier to see.
01 / The instrument
Start with what is being issued.
The instrument determines the starting relationship. Its specific terms determine the economics and rights that follow.
| Instrument | Starting position | Terms to examine |
|---|---|---|
| Preferred equity | Shares purchased now, with negotiated economic and governance rights. “Preferred” does not guarantee repayment or a return. | Share price, capitalization, preference, conversion, voting, and investor rights. |
| Convertible note | Debt that can convert into shares under specified conditions. Notes typically include interest and maturity provisions. | Conversion triggers, valuation cap, discount, interest treatment, maturity provisions, and any security or seniority. |
| YC SAFEStandard U.S. forms | A future-equity contract without interest or a maturity date. The form also addresses liquidity and dissolution events. | Which version, conversion formula, valuation cap or discount if included, event treatment, and side letters. |
YC offers different SAFE versions; a cap and a discount are not both present in every form. A cap is an input to conversion mechanics, and the capitalization definition and financing terms affect the outcome.
References: YC SAFE forms, Carta on convertible securities, and NVCA model documents.
02 / Ownership
Connect value with capitalization.
For a simple priced round, post-money value includes the new primary capital. Existing holders own a smaller percentage when new shares are issued.
Hypothetical priced round
A $2 million investment at $8 million pre-money.
The example uses a single price and excludes convertible conversion and an option-pool increase.
$8MPre-money equity value
$2MNew primary capital
$10MPost-money equity value
New investors own 20%. An existing 20% holding becomes 16%.
The existing holding falls by 4 percentage points, representing a 20% relative reduction. The change in percentage alone does not establish a loss in dollar value.
Change the round in Venture MathRead the option-pool treatment.
Increasing a pool before a financing generally dilutes existing holders before the new money arrives; a later increase generally dilutes new investors too. An unallocated reserve is different from issued shares.
References: Carta on pre-money and post-money value and option-pool mechanics.
03 / Distribution of proceeds
Same proceeds. Different distributions.
A liquidation preference specifies a priority amount. Participation and conversion determine how the preferred holder can share in the remaining value.
Non-participating preferred
In this model, the holder takes the available preference or converts to common for the ownership-based payout, choosing the better result.
Uncapped participating preferred
In this model, the holder receives the available preference and then its ownership share of the remainder, with no participation cap.
| Cash for equity | Non-participating investor | Common holders | Uncapped participating investor | Common holders |
|---|---|---|---|---|
| $5M | $2MTakes preference | $3M | $2.6M$2M + 20% of $3M | $2.4M |
| $20M | $4MConverts to common | $16M | $5.6M$2M + 20% of $18M | $14.4M |
Assumes one preferred class and one common class, with proceeds already available for equity distribution after prior obligations. Other classes, preference stacks, dividends, fees, taxes, escrow, earnouts, and option-exercise mechanics are excluded. A preference cannot create proceeds that are not available.
Mechanism reference: Carta on liquidation preferences. The numbers above are illustrative arithmetic, not a forecast.
04 / Rights & relationship
Look beyond the price.
Economic rights and governance rights answer different questions. Read their scope and conditions in the governing documents.
Pro rata rights
An opportunity to participate in later financing under agreed conditions. Maintaining a stake through a new investment requires additional capital.
Information rights
Agreed reports and access to information. Check the scope, eligible holders, confidentiality requirements, and exceptions that apply.
Governance rights
Board representation, voting arrangements, protective provisions, and observer status are distinct. Understand which decisions each right covers.
Document references: NVCA’s financing-document set and YC’s optional pro rata side letter.
Put the pieces together
Read the documents as a set.
Use the term sheet as a map, then confirm the capitalization, economics, and rights in the documents that govern the investment. Keep the assumptions visible when modeling an outcome.
Sources & further reading
Y CombinatorSAFE financing documents and guidance ↗
NVCAModel financing documents ↗
CartaConvertible notes and SAFEs ↗
CartaPre-money and post-money value ↗
CartaOption-pool mechanics ↗
CartaLiquidation rights and preferences ↗
Venture Decoded’s explanations simplify the mechanisms for learning. Contract versions and negotiated terms differ. Sources checked October 2026; definitive documents determine the actual rights and calculations.