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Valuation Cap
The maximum valuation at which a convertible note or SAFE will convert into equity.
Formula
Conversion with cap:
Shares = Investment / (Cap / Fully Diluted Shares)
Example: $500K SAFE, $8M cap, Series A at $16M.
Without cap: $500K / ($16M/10M shares) = 312,500 shares
With cap: $500K / ($8M/10M shares) = 625,000 shares
Definition
What is a Valuation Cap?
A valuation cap sets the maximum price convertible investors pay when converting to equity. If the cap is $10M and the company raises at $20M, convertible holders convert as if the valuation were $10M, getting 2x the shares.
Cap vs. No Cap
Uncapped notes are founder-friendly but rare. Investors want caps to protect against massive dilution if the company explodes in value. The cap is essentially a maximum conversion price.
Setting the Cap
Caps should reflect a reasonable markup from your current state plus expected progress before priced round. Too low a cap punishes success; too high offers investors no protection.
Example
SAFE investment: $200K with $6M cap.
Series A: $2M at $15M post-money.
Series A price: $15M / 15M shares = $1.00/share
Cap price: $6M / 15M shares = $0.40/share
SAFE converts at $0.40 (the cap).
SAFE holder gets: $200K / $0.40 = 500,000 shares
Instead of 200,000 shares without cap.
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