What are the major terms in convertible notes and SAFEs (e.g., discount and valuation cap)?
Takeaway: The post-money valuation cap is the single most important economic term in a modern SAFE, directly setting the percentage of the company an investor is purchasing, while the discount has become a less common feature.
The core purpose of a SAFE (Simple Agreement for Future Equity) is to raise capital quickly while deferring a formal valuation of the company. However, early-stage investors are taking the most risk and require a mechanism to ensure they are rewarded with a better price than the investors in the next round. This compensation is delivered through two primary economic terms: the Valuation Cap and, less commonly, the Discount.
The Valuation Cap: The Key Economic Driver
The valuation cap is the central term in any SAFE negotiation. It sets the maximum valuation at which the investor's money will convert into stock in a future priced round, protecting the early investor's upside.
The Modern Standard (Post-Money Cap): In the current startup ecosystem, the vast majority of SAFEs use a post-money valuation cap. This provides a simple and clear calculation of the ownership being sold.
How It Works (Example): An angel invests $100k on a SAFE with a $10 million post-money valuation cap. In doing so, the investor has effectively purchased 1% of the company ($100k is 1% of $10M). The ownership is fixed, regardless of how much is raised in the future.
The Discount: A Less Common Feature
A discount gives the SAFE holder the right to convert their investment into stock at a specific discount (e.g., 20%) to the price paid by the new investors in the priced round.
The Historical Context: In the past, it was common for a SAFE to include both a valuation cap and a discount, with the investor receiving the benefit of whichever was more favorable.
The Current Market: Today, this "cap and discount" structure is much less common. The vast majority of SAFEs issued by startups now feature only a post-money valuation cap. A discount is now typically only seen in specific situations, such as a "bridge" SAFE issued between priced rounds or in a more difficult fundraising market where investors have more leverage.
Why the Shift Away from the Discount?
The shift to a "cap-only" post-money SAFE was driven by a desire for simplicity and clarity. A simple post-money cap allows founders and investors to know, with certainty, the exact percentage of the company that is being sold with each SAFE. It makes modeling dilution straightforward and removes the more complex calculations required by a dual "cap and discount" structure.
For founders, the negotiation of the post-money valuation cap is the primary "price" negotiation in a seed-stage fundraising round. It is the single key term that determines how much ownership an investor receives and how much dilution the founders will take.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.