Convertible Note Corporation With Cap And Discount
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FAQ
A valuation cap is used in a convertible note to give the noteholders a ?ceiling? value at which their investment will convert and, in turn, that gives them a ?floor? in regard to their ownership.
Discount. The discount rate, typically 15% to 25% percent, gets applied to the per-share price of the new investor. For example, let's say your convertible note had a 20% discount and the new investors are paying $1 per share. The convertible note investor will convert at $0.80 per share.
The ?SAFE holder? gets 0.32% of the company, instead of 0.20% ? nearly a third more than without the cap. Sometimes, a SAFE will have both a cap and a discount. In this scenario, the SAFE holder will pick either the cap or the discount to use.
A "valuation cap" entitles note holders to convert the outstanding balance on the 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).
The discount entitles them to convert their investment at a lower price than what the following round's equity investors will pay. The conversion valuation cap (or ?cap?) is a new mechanism for rewarding early investors for the risk they take and, presumably, the efforts they make to help the firm grow in value.