Full Definition
A valuation cap is the maximum company valuation at which a SAFE or convertible note will convert to equity in a future financing round. It protects early investors by ensuring they receive a favorable conversion rate even if the company's valuation increases dramatically before the next priced round.
How Valuation Caps Work
If a SAFE has a $5M cap and the company later raises a Series A at $20M pre-money, the SAFE converts as if the company were valued at $5M (not $20M), giving the investor 4x more shares than they would get without the cap.
Cap vs No Cap
- With Cap: Standard for most SAFEs; gives investors downside protection and upside participation
- Without Cap: Very founder-friendly; investors accept risk of converting at whatever the next round's price is
- Cap + Discount: Investor gets the better of the two; common in early rounds
Real-World Example
An investor puts $100K into a SAFE with a $4M cap. The Series A prices at $12M pre-money. The SAFE converts at the $4M cap, giving the investor 2.5% instead of ~0.8%.
Related Terms
A Y Combinator-created investment instrument that converts to equity in a future priced round.
A short-term debt instrument that converts into equity during a future financing round.
A percentage discount given to SAFE or convertible note holders on the next round's price per share.
The value of a company before receiving new investment in a funding round.
The reduction in existing shareholders' ownership percentage when new shares are issued.
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