Valuation Caps Explained: How to Think About Your SAFE Cap

The valuation cap is often the first number discussed in a SAFE negotiation—and the most misunderstood. Let's clear up the confusion.

What Is a Valuation Cap?

A valuation cap is the maximum valuation at which a SAFE (or convertible note) will convert to equity. It protects early investors from excessive dilution if your company's value increases dramatically before conversion.

Example:

• SAFE: $500K at $10M cap
• Series A: $50M valuation
• Without a cap: Investor would get 1% ($500K / $50M)
• With a cap: Investor gets 5% ($500K / $10M)

The cap rewards early investors for taking risk when your company was less proven.

Cap vs. Valuation: Not the Same Thing

Your valuation cap is NOT your company's valuation. It's a ceiling on the conversion price. Important distinctions:

• A $10M cap doesn't mean your company is worth $10M
• You might raise at a $5M cap when your "fair" value is $3M—investors are paying a premium for access
• You might also raise at a $10M cap when your value is $15M—investors are getting a discount for early commitment

The cap is a negotiated term that reflects risk, timing, and leverage—not a precise valuation.

How to Think About Your Cap

What Investors Consider

• Stage and traction (revenue, users, team)
• Market size and competitive landscape
• Expected Series A valuation
• Their target ownership percentage

What You Should Consider

• How much dilution you're taking now
• What valuation you'll need for Series A to make the cap matter
• Competitive dynamics among investors
• Your actual need for capital and leverage

The Math That Matters

With a post-money SAFE (the current standard), the math is simple:

Investor ownership = Investment amount / Post-money cap

$500K on a $10M post-money cap = 5% ownership. Always.

This means you can calculate exactly how much dilution you're taking across all your SAFEs by adding up the percentages.

Common Mistakes

1. Setting the cap too low to raise quickly. A $4M cap might close your round fast, but you're giving away more equity than necessary if you had leverage.

2. Setting the cap too high and signaling problems. If you can't raise at a $20M cap, lowering it later signals weakness. Start realistic.

3. Ignoring the total raise amount. A $10M cap is great if you're raising $500K (5% dilution). It's terrible if you're raising $3M (30% dilution).

The Bottom Line

Your valuation cap should reflect a realistic discount to your expected Series A valuation—typically 25-40% below. This gives early investors a meaningful reward for risk while preserving founder ownership.

Don't anchor to vanity numbers. Anchor to dilution you can live with.