Definition
Valuation Cap
A valuation cap is the maximum valuation at which a convertible note or SAFE converts into equity, protecting early investors if the startup's value soars.
If an investor's SAFE has a ₹40 crore cap and the next round prices the company at ₹100 crore, the SAFE still converts as if the company were worth ₹40 crore, giving the early investor more shares to reward their early risk. Without a cap, the early investor would convert at the (higher) round price and get less.
The cap, together with the discount, is the key economic term in a convertible. A lower cap is better for the investor and more dilutive for founders. The investor usually gets the benefit of whichever of the cap or the discount yields more shares.
Related terms
- SAFE NoteA SAFE (Simple Agreement for Future Equity) is an instrument by which an investor gives a startup money now in exchange for equity in a future priced round.
- Convertible NoteA convertible note is short-term debt that converts into equity at a future financing round, typically at a discount or valuation cap.
- Discount (Convertible)A conversion discount lets a convertible note or SAFE convert into equity at a reduced price compared with the next round's investors.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.