ContractsCounsel Logo
Home Blog Valuation Cap

Jump to Section

ContractsCounsel has assisted 157 clients with safe notes and maintains a network of 98 startup lawyers available daily. These lawyers collectively have 31 reviews to help you choose the best lawyer for your needs.

A valuation cap limits the price at which a SAFE (Simple Agreements for Future Equity) may eventually convert to equity ownership. This pre-negotiated sum "caps" the conversion price once shares are issued and represents the highest valuation at which an investor can convert a SAFE into equity. Startup entrepreneurs frequently propose value caps as incentives to entice early investors because investing in startups involves considerable risk.

It applies to conventional fundraising methods and SAFEs, financing tools that grant early investors the same right to future equity in the company as more conventional funding methods while being easier, less expensive, and quicker to execute.

What Is a Valuation Cap?

A valuation or conversion cap is put on the price at which convertible notes or SAFEs will convert to equity in the future (if we're dealing with convertible notes). The lower end of a valuation cap, or the price in subsequent funding rounds, gives holders of SAFE or convertible notes the option to convert their investment into stock.

A valuation cap ensures that an investor's investment in a startup or business through a SAFE or convertible note is converted into equity at a predetermined maximum price. It's critical to remember that this maximum price is restricted, even if a company's worth increases in succeeding rounds and exceeds the valuation cap.

What is a Convertible Note?

A business may obtain initial cash from investors in various ways, including equity investments. Using convertible notes as a different way to raise money has various benefits.

A convertible note is essentially a loan from an investor to your startup or business. As with convertible notes, this loan will turn into equity when a trigger event occurs. The conclusion of profitable future investment rounds, exit occasions, or the upcoming maturity date is a few examples of these events.

How Does a Valuation Cap Work?

Holders of notes with a "valuation cap" have the option to convert the remaining principal into stock at the lower of- (i) the valuation cap or (ii) the share price in a qualifying financing (or, if there is a discount in the note, then the discounted price per share). It is not a value of the business based on its current assets or plans. It is designed to ensure an investor doesn't lose out on a company's considerable growth between selling convertible notes and qualified financing. In all fairness, the investor should feel somewhat secure knowing that even if they invest at a time when the firm has little value, the note won't convert at a ridiculously high price, depriving them of the opportunity to benefit from the full potential of their initial investment.

Additionally, a valuation cap shields investors from abnormally low equity conversion rates in later valuation rounds. In general, sophisticated investors insist on a cap since, without one, their investment will lose value if the company's value begins to soar. Discounts and caps cannot be used concurrently; an investor must decide between the two at the subsequent round and choose which will be more profitable for them financially.

  • A Valuation Cap from the Viewpoint of an Investor

    From an investor's perspective, this conversion of notes or SAFEs into equity will occur during a subsequent investment round, when another investor will likely participate. Naturally, the new entrant will want a piece of the action, or equity, in return for their investment. The valuation cap's purpose is to best protect or reward initial investors in the future. Early investors, in particular, can benefit from the value cap since it lessens the risk they took when they entrusted their money to a project that was taking place in an extremely risky environment.

  • A Valuation Cap from the Viewpoint of a Startup

    As was emphasized at the beginning of this post, the valuation cap is crucial for entrepreneurs. Its significance is focused on a point that has been purposefully left out up until this point. What is that, then? Well, it's the valuation itself, strange as it may sound. The "lack" of any valuation in these initial seed rounds, to be more accurate, is what makes this term so important.

  • A "conflict of interests" between entrepreneurs and investors because of the valuation cap

    In the preceding part, we concentrated on investors and startups eventually reaching an investment agreement despite not having a specific estimate of the firm valuation. They do, however, have a valuation cap. It is seen as a reflection of how much the startup is worth when investors invest. Investors want that value to be as low as possible.

    Considering that they will eventually need to convert their notes or SAFEs into equity, they wish to reduce the risk of overpaying. In conclusion, investors often attempt to pull the value down. On the other hand, startups will now work to increase that value. Naturally, they must safeguard their business against potential interest dilution.

    More specifically, there is a good likelihood that a firm will have a lesser percentage of equity when the time comes for convertible notes or SAFEs to be converted into equity, which occurs during a post-money valuation, especially in one particular instance. Of course, this will happen when the initial valuation cap turns out to be significantly lower than the valuation determined at that time.

  • Benefits of Valuation Cap

    Investors are encouraged to make early investments in potential firms by valuation caps. For instance, the investor will receive twice as much equity in return for their investment if the value cap is half that of a startup or firm at the time of the subsequent funding round. An investor may receive a bigger equity stake in the following funding round with a lower valuation cap. Additionally, a valuation cap shields investors from abnormally low equity conversion rates in later valuation rounds.

Meet some lawyers on our platform

Brian S.

16 projects on CC
CC verified
View Profile

Damien B.

19 projects on CC
CC verified
View Profile

Daniel R.

151 projects on CC
CC verified
View Profile

Danny J.

13 projects on CC
CC verified
View Profile

Drawbacks of Valuation Cap

However, valuation caps may have disadvantages. As the maximum price is constrained, the startup value in later rounds could surpass the cap, which would be bad for the investor. Suppose a company's valuation at the time of the next fundraising round reaches $2 million, for instance, and an investor's SAFE has a valuation cap of $1 million. In that case, the SAFE will still convert into equity at the cap price of $1 million. Founders frequently provide early investors with discounts in addition to caps as restitution for this.

Key Terms

  • Capital Asset Pricing Model (CAPM): The Capital Asset Pricing (CAPM) Model is the most commonly utilized risk/return standard used to estimate the equity price of capital.
  • Debt Financing: Raising funds for a company through loans or by administering bonds.

Conclusion

The valuation cap is one of the seed investment agreements' most important provisions and instruments. You could consider it a source of conflict between you and your investors. Even yet, it unquestionably acts as a tool with a track record of being quite effective at raising funds. Whatever the kind of agreement, convertible notes or SAFEs, such investments ultimately continue mostly due to a value cap. It protects your investors from overpaying for shares of your startup at a later stage while also serving the interests of your startup. The mission of ContractsCounsel is to assist people and businesses in finding reasonably priced legal counsel.


ContractsCounsel is not a law firm, and this post should not be considered and does not contain legal advice. To ensure the information and advice in this post are correct, sufficient, and appropriate for your situation, please consult a licensed attorney. Also, using or accessing ContractsCounsel's site does not create an attorney-client relationship between you and ContractsCounsel.


Need help with a SAFE Note?

Create a free project posting
Clients Rate Lawyers 4.9 Stars
based on 11,549 reviews

Meet some of our Lawyers

Michael O. on ContractsCounsel
View Michael
5.0 (4)
Member Since:
February 14, 2022

Michael O.

Managing Attorney
Free Consultation
Los Angeles
17 Yrs Experience
Licensed in CA, NY
University of Southern California

A corporate and commercial attorney with experience in transactional legal services including corporate and finance transactions, mergers and acquisitions, real estate, commercial contracts, bankruptcy, restructuring, international business transactions and general counsel services. Additional background skills and experience include investment banking, financial analysis, and commercial litigation. Sectors covered include technology, media, franchises, and business services providers, from start-ups to medium and large enterprises.

Meghan P. on ContractsCounsel
View Meghan
4.8 (6)
Member Since:
February 15, 2021

Meghan P.

Attorney
Free Consultation
Denver
6 Yrs Experience
Licensed in CA
University of Dayton

I am a licensed attorney and a member of the California Bar. I graduated from the University of Dayton School of Law's Program in Law and Technology. I love IP, tech transfers, licensing, and how the internet and developing technology is changing the legal landscape. I've interned at both corporations and boutique firms, and I've taken extensive specialized classes in intellectual property and technology law.

Daehoon P. on ContractsCounsel
View Daehoon
4.7 (119)
Member Since:
November 26, 2021

Daehoon P.

Corporate and Commercial Lawyer
Free Consultation
New York, NY
8 Yrs Experience
Licensed in NY
American University Washington College of Law

Advised startups and established corporations on a wide range of commercial and corporate matters, including VC funding, technology law, and M&A. Commercial and Corporate Matters • Advised companies on commercial and corporate matters and drafted corporate documents and commercial agreements—including but not limited to —Convertible Note, SAFE, Promissory Note, Terms and Conditions, SaaS Agreement, Employment Agreement, Contractor Agreement, Joint Venture Agreement, Stock Purchase Agreement, Asset Purchase Agreement, Shareholders Agreement, Partnership Agreement, Franchise Agreement, License Agreement, and Financing Agreement. • Drafted and revised internal regulations of joint venture companies (board of directors, employment, office organization, discretional duty, internal control, accounting, fund management, etc.) • Advised JVs on corporate structuring and other legal matters • Advised startups on VC funding Employment Matters • Drafted a wide range of employment agreements, including dental associate agreements, physician employment agreements, startup employment agreements, and executive employment agreements. • Advised clients on complex employment law matters and drafted employment agreements, dispute settlement agreements, and severance agreements. General Counsel • As outside general counsel, I advised startups on ICOs, securities law, business licenses, regulatory compliance, and other commercial and corporate matters. • Drafted or analyzed coin or token sale agreements for global ICOs. • Assisted clients with corporate formations, including filing incorporation documents and foreign corporation registrations, drafting operating and partnership agreements, and creating articles of incorporation and bylaws. Dispute Resolution • Conducted legal research, and document review, and drafted pleadings, motions, and other trial documents. • Advised the client on strategic approaches to discovery proceedings and settlement negotiation. • Advised clients on employment dispute settlements.

Muhammad Yar L. on ContractsCounsel
View Muhammad Yar
5.0 (1)
Member Since:
November 16, 2023

Muhammad Yar L.

Business Lawyer
Free Consultation
Pakistan
6 Yrs Experience
Licensed in NY
University of London

I am Muhammad, a legal counsel, technology law advisor, and corporate and commercial law expert, licensed to practice in New York State. I graduated from University of London and Georgetown Law Center and have about 7 years of experience in corporate and commercial law. As a As a technology law advisor, I possess deep insights into SaaS agreements, master service agreements, master subscription agreements, and SaaS Agreements, among others.

Starcee R. on ContractsCounsel
View Starcee
Member Since:
November 14, 2023

Starcee R.

Managing Partner
Free Consultation
Altamonte Springs, FL
8 Yrs Experience
Licensed in FL
Stetson university

Mrs. Rivera graduated from Palmetto High School in 2009 and went on to attend Florida State University in Tallahassee, FL. After graduating from Florida State University with a B.S. degree in Criminology and a minor in Philosophy in April 2012, she went on to attend the University of Central Florida where she earned a M.S. Degree in Criminal Justice in August 2013. That same month, She started law school at Stetson University College of Law. ​ While in Law school, Mrs. Rivera participated on Stetsons #1 Trial team. In May 2016, Mrs. Rivera graduated with her law degree and in December 2016, Mrs. Rivera obtained her Masters in Law from Stetson University through its Joint J.D./LL.M degree in Advocacy program. Mrs. Rivera was a part of the first graduating class for this joint program at Stetson University. ​ As a Law student, Mrs. Rivera was a law clerk at a well-known plaintiffs employment law firm in Tampa, FL and also interned for the Honorable Judge Edward Larose of the Second District Court of Appeal where she was able to draft PCA opinions draft legal opinions that were ultimately published. Mrs. Rivera also went on to participate as a Certified Legal Intern (CLI) with the 6th Judicial Circuit Office of the Public Defender in Pinellas County, FL and an Intern for LegalAid of Manasota in Sarasota, FL. ​ After Law School, Mrs. Rivera began her legal career working as a Public Defender with the Ninth Judicial Circuit Office of the Public Defender in Orlando, FL. During her time as a Public Defender, Mrs. Rivera litigated more than 20 trials, representing both adults and juveniles accused of Misdemeanor and Felony offenses. After engaging in extensive civil, criminal and family law litigation, Mrs. Rivera decided it was time to finally open Allstarr Legal, P.A. in order to provide both affordable and quality legal representation to the people of the State of Florida. Mrs. Rivera practices throughout the entire state of Florida.

Francine L. on ContractsCounsel
View Francine
Member Since:
November 15, 2023

Francine L.

Legal Counsel
Free Consultation
New York, New York
36 Yrs Experience
Licensed in NY
Quinnipiac University School of Law

I am a multi-degreed attorney with more than 17 years of criminal trial experience and more than 15 as a general legal consultant. I'm licensed to practice in New York State.

Dimitry K. on ContractsCounsel
View Dimitry
Member Since:
November 14, 2023

Dimitry K.

Managing Partner
Free Consultation
Philadelphia
16 Yrs Experience
Licensed in NJ, PA
Rutgers School of Law-Camden

Prior to becoming an attorney, Mr. Dimitry Alexander Kaplun had been involved with many industries and professions, and helped manage, create, and advise a wide range of businesses around the world. While at Drexel University as a computer science major, he became an NASD licensed representative and was employed by Fortune 100 insurance companies, including Prudential, AIG, and NY Life, first specializing in financial investments for life and annuity products, and then expanding his expertise to mutual finds, stocks, environmental insurance, and real property. Due to his technical expertise and a clear understanding of business rules, he was soon brought on board to help assist those companies with coding their interface for the Y2K switch. Soon after switching his major to business, Mr. Kaplun worked for a telecommunication service company first in quality assurance and then as a database programmer and developer, with sole and exclusive responsibilities for a multitude of warehouses located around the continental United States. Working on-site and from the company headquarters, he was responsible for streamlining processes for internal departments while fulfilling the quickly changing needs to the company clients, most notably Verizon Wireless. Mr. Kaplun opened his practice in 2008. Prior to starting his practice, he worked as a paralegal instructor for Prism Career Institute, creating the lesson plans for the whole program and focusing his instruction on substantive and procedural laws for general practitioners. Mr. Kaplun also worked as an associate for The Law Office of Keith Owen Campbell PC, focusing on Family and Matrimonial Law, and assisted the law firm of Jeffrey Neu and Associates in securities research as well as various contact and sales agreements, mainly online reseller agreements. He currently focuses his energy on representing individuals and companies in liability insulation, contracts and business agreements, and other legal concerns that crop up in the regular operation of doing business.

Find the best lawyer for your project

Browse Lawyers Now

Quick, user friendly and one of the better ways I've come across to get ahold of lawyers willing to take new clients.

View Trustpilot Review

Need help with a SAFE Note?

Create a free project posting
Clients Rate Lawyers 4.9 Stars
based on 11,549 reviews
CONTRACT LAWYERS BY TOP CITIES
See All Startup Lawyers
VALUATION CAP LAWYERS BY CITY
See All Valuation Cap Lawyers

Contracts Counsel was incredibly helpful and easy to use. I submitted a project for a lawyer's help within a day I had received over 6 proposals from qualified lawyers. I submitted a bid that works best for my business and we went forward with the project.

View Trustpilot Review

I never knew how difficult it was to obtain representation or a lawyer, and ContractsCounsel was EXACTLY the type of service I was hoping for when I was in a pinch. Working with their service was efficient, effective and made me feel in control. Thank you so much and should I ever need attorney services down the road, I'll certainly be a repeat customer.

View Trustpilot Review

I got 5 bids within 24h of posting my project. I choose the person who provided the most detailed and relevant intro letter, highlighting their experience relevant to my project. I am very satisfied with the outcome and quality of the two agreements that were produced, they actually far exceed my expectations.

View Trustpilot Review

Need help with a SAFE Note?

Create a free project posting
Clients Rate Lawyers 4.9 Stars
based on 11,549 reviews

Want to speak to someone?

Get in touch below and we will schedule a time to connect!

Request a call

Find lawyers and attorneys by city