SAFEs: What is a Valuation Cap v. a Discount Rate?
This week’s question: What’s the difference between a Valuation Cap and a Discount Rate in a SAFE?
Our answer: When you raise money on a SAFE, you generally have two levers to determine how much of a discount your investors will eventually receive on the future issued stock; these are the valuation cap and the discount rate. Both are discount mechanisms that reward early-stage investors for taking risk before a priced round, but they work in different ways. A valuation cap sets the maximum valuation at which the SAFE converts; meaning if your next round is at a higher valuation, the SAFE investor still converts at the lower “capped” valuation (e.g. a $10M post-money valuation cap means that if the new money priced round is raised at $20M then the SAFE investor’s SAFE converts as if the company were actually valued at $10M, for essentially a 50% discount). A discount rate, by contrast, gives the investor a percentage discount on the per-share price in the next priced round (e.g. a 20% discount rate means that if new money investors pay $1.00 per share then the SAFE investor’s SFE converts as if the shares are at $0.80 per share). Some SAFEs include both a valuation cap and a discount rate, allowing the investor to convert at whichever lever produces the better price. Understanding how these mechanics work is essential because they directly drive your dilution and determine the degree to which your SAFE financing is founder-friendly (or investor-friendly).
Key Considerations:
Valuation Cap only. A valuation cap only SAFE is the most common form of SAFE because it gives investors clear ownership expectations and a hard ceiling on valuation. However, you should set the cap thoughtfully to balance a SAFE investor’s upside against your own dilution because if you set the cap too low, you can take a disproportionate dilution hit when the SAFE converts.
Discount Rate only. We often recommend starting with a discount-only SAFE in the market standard range of 10% to 25%. A discount rate only SAFE is highly favorable to startups because the discount scales with the actual new money price in the round, the impact is straightforward to model and it avoids overly aggressive caps that can lead to punishing dilution for founders.
Discount Rate and Valuation Cap. Combining a discount rate and a valuation cap should be avoided unless absolutely necessary to raise. Although offering both in a single SAFE may seem like a strong incentive for investors, pairing a low cap with a steep discount can be highly dilutive to founders in the next round and makes modeling outcomes significantly more complex.
Consistency Matters. Founders sometimes end up issuing SAFEs with dramatically different caps and/or discount rates to appease early investors, creating a messy and hard to model cap table. Whether you decide to use valuation caps or discount rates (or both) you should aim to keep your terms consistent and aligned so future fundraising is cleaner, easier to model and there are no unexpected dilution shocks.
Why It Matters
For founders, valuation caps and discounts may seem straightforward and easy to determine terms in a SAFE, but they largely determine how much of your company you’re giving away. Low caps, large discounts, and/or inconsistent terms across investors can cause major dilution overhang, complicate future rounds and raise red flags for new investors reviewing your cap table. As a result, it’s critical to carefully set valuation caps and discount rates as strategic tools, not casual negotiation points. When you choose terms intentionally, keep them consistent and model dilution scenarios regularly, you can use valuation caps and/or the discount rate to confidently raise fast, maintain founder ownership and avoid painful surprises that trip up many founders. A little foresight now protects a lot of headaches later.
