Valuation Cap

The valuation cap is a term associated with convertible securities such as convertible notes, crowd notes, and simple agreements for future equity (SAFEs). These securities contain an equity conversion provision  related to the next qualified equity financing round and typically have features such as a valuation cap, a discount, or both – and either of them can affect the price at which the note converts to equity. A valuation cap allows investors to convert the outstanding balance on the convertible note into shares of stock at the lower of (i) the valuation cap or (ii) the price per share in a qualified financing (or, if there is a discount in the note, then the discounted price per share).

Valuation cap does not refer to the valuation of the company based its projections or assets. It is intended to reward early investors for taking on additional risk by setting a maximum price at which their convertible security investment will convert to equity.