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What is a Valuation Cap?

Posted by Erica Duignan Minnihan on May 11, 2016 3:00:00 PM

A valuation cap is something that applies to convertible notes. A convertible note is a security that is a hybrid of both debt and equity. Notes are issued in the place of priced equity, typically when a company is raising less than a million dollars and does not want to generate the legal expenses associated with a priced round.

When the company issues a larger amount of capital, the notes will have the option to “convert” into the newly issued securities at a pre-set “discount” to the price of the follow-on round. These discounts typically range from 15 to 25 percent. However, in order to provide investors with some of the protections of a priced round, they add a “cap” to the valuation. The “cap” sets the highest valuation that can be used to determine the conversion price of the notes.

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Topics: Venture Investing, Venture Investing Academy, Direct Investment, Valuation Cap