A valuation cap sets the maximum price at which a SAFE or convertible note converts into stock, so early investors get a better price if the company’s priced round comes in higher. On a post-money SAFE, the cap also fixes the investor’s ownership: the purchase amount divided by the cap. The best way to set a cap is to decide what percentage of the company you’re willing to sell in this round, not to guess at a valuation.
Key takeaways
- On a post-money SAFE, ownership equals the purchase amount divided by the cap. $500,000 on a $5,000,000 cap is 10%.
- Each additional post-money SAFE dilutes the existing stockholders, mainly the founders, not the earlier SAFE holders.
- A practical starting point for a cap is the amount you’re raising divided by the percentage you’re willing to sell.
- A cap alone is the market default. If an investor also gets a discount, they get whichever produces more shares.
- A SAFE has no share count or price per share. The shares are calculated when the SAFE converts.
- A “$12 million pre-money” term sheet usually counts your converting SAFEs inside the pre-money, so founders, not the new investors, absorb that dilution.
What is a valuation cap?
A SAFE or convertible note converts into preferred stock when the company raises a priced round. Without a cap, the investor would convert at the same price as the new investors, which gives them no reward for investing earlier. The cap fixes the most the early investor will pay per share. If the priced round values the company above the cap, the early investor converts at the lower, capped price and gets more shares for the same money.
Say a SAFE has a $10,000,000 cap and the next round prices the company at $20,000,000. The SAFE holder converts at roughly half the new investors’ price per share, so they get about twice as many shares per dollar. If the round prices the company below the cap, the cap doesn’t matter, and the SAFE converts at the round price (or at a discount to it, if the SAFE has one).
What’s the difference between a post-money and a pre-money cap?
A post-money cap, used in the current standard SAFE, values the company after all the SAFEs are counted. The SAFE converts based on the company’s capitalization just before the priced round, which includes all outstanding shares, all options and the unissued option pool, and all SAFEs and notes converting at the same time. Any option pool increase made as part of the priced round isn’t counted, so the SAFE holders share that dilution with the founders. The result is that the investor’s percentage is known at signing: purchase amount divided by cap.
A pre-money cap, used in older SAFEs and most convertible notes, values the company before the convertible money comes in. The investor’s final percentage depends on how much else converts alongside it, so nobody knows the exact number until the priced round. See SAFE vs Convertible Note.
How do I set the cap on my first SAFE round?
Work backward from the dilution you’ll accept. Divide the amount you’re raising by the percentage you’re willing to sell. Raising $1,000,000 and willing to sell 20% means a $5,000,000 post-money cap. Many founders aim to sell somewhere between 15% and 25% in an early round, then adjust for traction, the strength of the team and what comparable companies are raising at. Founder Fridays publishes median pre-seed and seed valuations each month, which is a useful check. If you and your investors are effectively agreeing on a valuation anyway and the round is large, a priced Series Seed may be worth the extra paperwork, because it settles the price and the share count now. See SAFE vs. Convertible Note vs. Priced Round.
Don’t push the cap as high as an investor will tolerate without thinking about the next round. You’ll want the priced round to come in above the cap. If it doesn’t, the SAFE holders’ cap gives them little benefit and you’ll be raising at a flat or lower valuation, which is a harder story to tell. See What Is a Down Round?.
Should my SAFE have a cap, a discount, or both?
A cap with no discount is the market default for a post-money SAFE. A discount, typically 10% to 20%, gives the investor a lower price than the new investors in the priced round. If the SAFE has both, the investor converts at whichever price gives them more shares. That means a low cap combined with a discount is a double concession. If an investor asks for both, counter with one or the other, and model both outcomes before you agree.
What happens when SAFEs convert in a priced round?
Here’s a simple example. A company has 10,000,000 shares on a fully diluted basis (founder stock plus the option pool). It raised a $500,000 SAFE on a $5,000,000 post-money cap. It now raises a Series Seed at a $12,000,000 pre-money valuation. Ignore any option pool increase.
With the cap, the SAFE converts into 10% of the company’s capitalization just before the new money: about 1,111,111 shares out of about 11,111,111. The Series Seed price is about $1.08 per share, so the SAFE holder’s shares are worth about $1,200,000 at the round price, more than twice what they paid.
If the same SAFE had no cap and only a 20% discount, the investor would get about 549,000 shares, roughly 5.2% of the pre-money capitalization, worth about $625,000 at the round price. The cap is worth far more to the investor than the discount whenever the round prices well above the cap.
Does a low cap give SAFE holders a bigger liquidation preference?
Not under the YC post-money SAFE. When a SAFE converts at the cap, the holder pays less per share than the new investors. If the holder received exactly the same preferred stock, every share would carry the new investors’ full liquidation preference. In the example above, the $500,000 SAFE would come with about $1,200,000 of preference. The YC SAFE avoids this by converting into a shadow series of the new preferred. It’s identical to the new investors’ stock except that its liquidation preference, and its starting price for anti-dilution, are based on the price the SAFE holder actually paid.
Convertible notes and non-YC SAFEs don’t always include this. Check the conversion language, and if it’s missing, ask for the same structure. Otherwise a note that converts at a deep discount to the round price can carry a preference worth several times what the investor paid. See Liquidation Preference.
Who absorbs the SAFE conversion when we price the round?
Usually the founders. A priced-round term sheet normally defines the pre-money valuation to include the shares issued when your SAFEs and notes convert, along with the option pool. The new investors’ price is the pre-money valuation divided by that larger share count, so they get exactly the percentage they’re paying for, and the dilution from the conversion falls on existing holders. Founders often read “$12 million pre-money” as meaning their existing shares are worth $12 million. Under a standard term sheet, they aren’t.
Take the example above and say the Series Seed raises $3,000,000. The standard approach counts the SAFE holder’s 1,111,111 shares inside the pre-money, which is how the price came out at $1.08. A common compromise, if you can negotiate it, treats the SAFE’s $500,000 purchase price like new money: the pre-money becomes $12,500,000 across the same share count, so the new investors absorb the dilution from the SAFE dollars and the founders absorb only the extra shares the cap gives the SAFE holder.
| How the SAFE is counted | Price per share | Founders and pool | SAFE holder | Series Seed investors |
| Standard: SAFE shares inside the $12M pre-money | $1.08 | 72.0% | 8.0% | 20.0% |
| Compromise: SAFE’s $500K added to the pre-money | About $1.13 | 72.6% | 8.1% | 19.4% |
| What founders often assume: SAFE shares outside the $12M | $1.20 | 73.5% | 8.2% | 18.4% |
New investors rarely accept the last row, because they would own less than they’re paying for. Read the capitalization definition in the term sheet before you sign, and model the round with every SAFE and note converting. The option pool raises the same question. See Option Pool Shuffle.
What happens if I stack SAFEs at different caps?
Each post-money SAFE dilutes the existing stockholders, mainly the founders. The earlier SAFE holders are protected. Raising $500,000 at a $5,000,000 cap and then $1,000,000 at an $8,000,000 cap sells 10% plus 12.5%, or 22.5% of the company, before any priced round. Raising at a higher cap later is normal and fine, but keep a running fully diluted model so you can see the total.
Watch your earlier documents. If an earlier SAFE has a most-favored-nation provision, those investors may be entitled to the better terms you give later investors, such as a lower cap or an added discount. See Equity Dilution.
What do I tell investors about share count and price per share?
A SAFE doesn’t have either. Tell them the ownership implied by the cap (purchase amount divided by the post-money cap) and explain that the actual number of shares and the price per share will be calculated when the SAFE converts in the priced round.
Go deeper: For a full walkthrough, see our Founder’s Guide to SAFEs and Founder’s Guide to Convertible Notes.
For more on how SAFEs work, see SAFE, Convertible Notes and Negotiating an Option Pool. If you’d like help setting up a SAFE round, see our SAFE service or contact us.
