The valuation cap is one of the most important aspects of a SAFE (Simple Agreement for Future Equity) or convertible note term sheet. The valuation cap sets a ceiling for the price per share that the investment will convert to equity at and is a way to reward early-stage investors for the additional risk they’ve taken on.
Let’s look at an example:
With the cap, the angel will get to convert their $500K at $2.50 per share ($5 x $5M Valuation Cap$10M New Valuation), whereas without the cap, they’d have to convert at the same $5 per share of the Series A investors. The valuation cap nets them twice as many shares as they would have gotten otherwise.
VCs defacto assume that the valuation cap will be their post-money valuation, so the cap is determining their entry price (along with the amount raised). As a result, many VCs will be focus on this as a major part of the negotiation.
The NFX Take
Valuations are probably the single most important term after the amount raised in a term sheet negotiation.
This along with company performance will determine the price and dilution of the investment round.
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