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Question about setting a valuation cap for a convertible note....

I need to set a valuation cap for our angel round. We're raising $1M, have strong interest from a number of angel groups and investors and now I need to propose a cap. The general message I'm hearing is (on a $1M raise, a compelling company and strong investor interest) that "it's not going to be $2M and its not going to be $10M". My lawyer suggested $10M, since founders are now being forcefully diluted by series A investors if the cap is too low and the valuation at A is too high. Of course, Angels are expecting $3M to $5M.

So, has anyone recently gone through this? I'd love to hear from both sides of the fence.

5 Replies

Stas Khirman
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Stas Khirman Entrepreneur • Advisor
SVOD Conference CoChair
A short answer : while cap is not a valuation, both sides are psychologically considering it to be the same. So think if you can honestly justify your current company valuation at X and set it as a cap ( or just +1m on top) ..

A long answer... well.. it depends ;-)
Joe Monastiero
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Joe Monastiero Advisor
CEO, Founder nFlate
It's my understanding that the objective of the cap is to try to set a fair valuation prediction for what expect the value of the company to be at the Series A funding date, which might be 12-18 months out. If I were to set the price at today's fair valuation, then it would be the same as a priced round.

The primary challenge I've been told is setting a cap too low (for example, $4M) when the actual valuation at series A is maybe $10M-$12M. With a 20% discount to the angel investors, and a 4M cap, the angel group would own 25% of the company, after converting the discount and VCs are forcing additional dilution on the founders to insure their favorable ownership position.

If we intend to raise A in 12-18 months, perhaps the right idea might be today's estimated valuation *1.5 or 2?
Rishi Sachdev
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Rishi Sachdev Entrepreneur
Human
"It's my understanding that the objective of the cap is to try to set a fair valuation prediction for what expect the value of the company to be at the Series A funding date, which might be 12-18 months out. If I were to set the price at today's fair valuation, then it would be the same as a priced round."

@Joe I haven't heard of this practice of using the Series A valuation to gauge the note cap. Do you have a link to a source? It seems like it would not properly award investors who are providing such a long (12-18 month) runway and taking early risk by doing the convertible note. In the deal flow I've paid attention to Series A valuations tend to be 3-4x the seed valuations, so early investors will want to see some of that upside.

What I've noticed on the convertible notes/SAFEs I've read in the past two years is a slightly higher than current fair market valuation cap with 20% discount, or current valuation cap with 0% discount.

Search for fifteen percent on this page to see a conversation around parting with percent ownership at the seed stage.

Joe Monastiero
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Joe Monastiero Advisor
CEO, Founder nFlate
@Rishi That was an EXCELLENT read, thanks for the forward. Really shed some light. Conway and Andreesson in the room together must have been entertaining. Ron mentioned that giving up 10-15% at the Angel stage made sense and that kind of validates my thought process.
Neil Gordon
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Neil Gordon Advisor
Board Member, Corporate Finance Advisor and Strategy Consultant
Convertible notes are renegotiated all the time, and most often when the cap is too low. A-round investors would rather cram down the angels than dilute the founders. In the bigger picture, they just need a cap table that works for them at the time they're putting in their money.
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