What is a Valuation Cap?
A Valuation Cap is a provision included in convertible funding agreements (such as SAFE Notes, ASAs, and Convertible Notes) that sets the maximum valuation at which the investor’s original money will convert into equity during a future priced funding round (e.g., Series A).
Its primary purpose is to reward early investors for taking the highest risk when the company's value was still low and unproven.
How the Cap Works The investor will calculate their conversion price using the lower of two values:
- The actual Series A Valuation.
- The pre-agreed Valuation Cap.
Example:
- You raised a Seed Round with a £10 million Cap.
- You successfully raise a Series A at a £50 million valuation.
The early investor will convert their initial investment at the £10 million Cap. This lower valuation ensures they receive a significantly higher percentage of equity than the new Series A investors, reflecting their early faith and risk tolerance.
Cap vs. Discount Most convertible instruments also include a Discount Rate (e.g., 20% off the Series A price). The investor will always convert their note using the mechanism—the Cap or the Discount—that gives them the most shares.
Key Takeaway: The Valuation Cap protects the early investor from dilution if the company experiences hyper-growth. It ensures their early funds secure a substantial percentage of the business.
