Valuation Cap
The highest valuation at which a SAFE or convertible note will convert. If the next round prices the company above the cap, the early investor converts as if the round had been at the cap and so receives more shares per dollar than the new money. It is the early investor’s reward for pricing risk before there was a price, and the closest thing a SAFE has to a valuation.
How a startup is financed · 11 of 26Next: Conversion Discount
Why Valuation Cap matters in interviews
The cap is the term that turns a SAFE or note from a loan of money into a bet on the company, and questions about it test whether a candidate understands what an early investor is being paid for. It also decides, more than any other number, what a stack of pre-seed instruments will take from the founders at the seed round.
How it works in practice
What it does. If the next round prices the company above the cap, the instrument converts as though the round had been at the cap, so the early investor pays a lower price per share than the new money. A $500k SAFE at a $5m post-money cap converting into a round at a $15m post-money gets three times the shares per dollar the new investor gets. If the round prices below the cap, the cap does nothing and the instrument converts at the round price, less any discount.
Cap against discount. A discount rewards the early investor by a fixed percentage whatever the round price; a cap rewards them more the better the company does. An instrument with both converts at whichever price is lower. For an investor who believes in the company, the cap is the term that matters; the discount is the floor.
What a cap is not. It is not a valuation of the company. Founders quote "we raised at a $10m cap" as if a round had been priced; nothing has been priced, and a cap set generously by a friendly angel says nothing about what a fund will pay. It is a ceiling on the conversion price, and the lower it is, the more of the company the early money takes.
What candidates get wrong
- Setting a cap above where the round will price. Then it never binds, and the early investor took pre-seed risk for a seed price.
- Setting a cap far below where the round prices. Then the SAFEs take a large fraction at conversion, and the seed lead prices the round knowing the founders are already thin.
- Treating a cap as a floor. It protects the investor against a high price, not the founder against a low one.
Valuation Cap: frequently asked questions
What is a valuation cap?
The maximum valuation at which a SAFE or convertible note will convert into shares at the next priced round. If the round prices the company above the cap, the instrument converts at the cap price and the early investor receives more shares per dollar than the new investors; if the round prices below the cap, the instrument converts at the round price, less any discount it carries. It is the early investor’s reward for taking risk before the company had a price.
What is the difference between a valuation cap and a discount?
A discount converts the instrument at a fixed percentage below the round price, typically 15 to 25%, regardless of the valuation. A cap converts it at a price implied by a maximum valuation, so the benefit grows with the round price. Where an instrument has both, it converts at whichever gives the lower price, so the discount matters only when the round prices below the cap.
Practise it
Take a company from founding through a SAFE and a priced seed round. Set the cap, the pre-money and the option pool, watch the price per share and every holder’s stake move, then check your own arithmetic against the table.
Open Cap Table Builder, free, 15 minWhere Valuation Cap comes up
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