Valuation Cap
AdvancedA valuation cap is the maximum company valuation at which a convertible note or SAFE converts into shares, ensuring early investors receive a lower price per share than later investors if the company's value rises sharply.
Early investors in convertible notes and SAFEs take significant risk before a company's value is set. If the company later raises money at a high valuation, these investors would receive few shares without a cap. The valuation cap protects them.
When the instrument converts, the price per share is based on the lower of the valuation cap and the valuation in the new round, often after any discount.
For example, an investor holds a SAFE with a valuation cap of 8,000,000. The company's next round values it at 20,000,000 before the new money. Because the cap is lower, the investor's shares are priced as if the company were worth 8,000,000, giving them two and a half times as many shares per unit invested as the new round's investors.
Valuation caps are a key negotiation point. A low cap benefits investors and dilutes founders more; a high cap does the opposite. If the next round's valuation is below the cap, the cap has no effect, though a discount may still apply.
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