By Doug Bend, founding father of Bend Legislation Group, PC, a legislation agency centered on small companies and startups.
We’ve helped dozens of startups increase their seed spherical of financing. Most of those firms have used the template Easy Settlement for Future Fairness (higher often known as a SAFE) with a valuation cap that Y Combinator has open-sourced right here.
Top-of-the-line attributes of the SAFE is the S, which stands for “easy” as a result of only some phrases sometimes must be negotiated with an investor. This helps to lower the period of time that the founders and the corporate’s legal professional must spend on negotiating phrases.
A very powerful of those is usually the valuation cap, which offers the investor with a ceiling valuation for calculating the variety of shares the investor will personal if the SAFE converts. The valuation cap, due to this fact, offers the investor with the peace of thoughts of figuring out that even when the corporate is valued at a a lot greater quantity, the investor will nonetheless have a flooring possession proportion within the firm if the SAFE converts.
Figuring out the quantity of the valuation cap is extra of an artwork than a science, however there are sometimes six key elements—let’s check out them.
1. The Total Fundraising Market
The primary issue is the general fundraising atmosphere for early-stage startups.
For instance, the present marketplace for elevating capital for startups has cooled off in current months and is extra pro-investor than it was in 2021.
The second issue is how a lot traction the corporate has. Traders usually tend to make investments with a better valuation cap if the startup can display that it has product-market match. For instance, does the corporate have any contracts that generate income? In that case, how a lot income and who’re these contracts with?
One other indicator of product market match is the quantity of person and income progress. For instance, buyers usually tend to put money into an early-stage startup if it has a minimum of 20% in month-over-month income progress or regular, important will increase within the variety of customers.
3. The Prior Monetary Returns Of The Founders
If the founders have a confirmed monitor file of prior exits, they’re extra more likely to have a better valuation cap.
Traders usually tend to make investments with a better valuation cap if the founder has beforehand offered the investor with a stable return. If the founder has carried out it earlier than, they’re extra more likely to do it once more.
4. The Expertise Of The Founders
Founders are more likely to have a better valuation cap if they’ve expertise that’s related to the startup, significantly if that have helps to develop and scale different startups in the identical business.
Traders usually tend to make investments with a better valuation cap not provided that it’s a nice thought, but in addition if the proper workforce is implementing that concept.
The business the startup is in may also impression the valuation cap for the SAFE. For instance, software program firms typically have a better valuation cap as a result of they’ll rapidly develop and scale.
Lastly, the valuation cap will possible be greater the extra leverage the startup has. For instance, the extra curiosity there’s within the funding spherical, the upper the valuation cap the startup will possible negotiate.
In distinction, if the startup has a brief monetary runway, the investor would possibly use that as leverage to barter a decrease valuation cap or not make investments in any respect in the event that they imagine the startup isn’t as more likely to be financially solvent.
As you may see, the valuation cap for a startup’s seed spherical is predicated on a number of variables. Founders are finest served working with their firm’s CPA and legal professional to gauge what valuation cap quantity is market and honest for each their firm and its buyers.
Disclaimer: This text discusses basic authorized points and developments. Such supplies are for informational functions solely and should not mirror essentially the most present legislation in your jurisdiction. These informational supplies usually are not meant, and shouldn’t be taken, as authorized recommendation on any explicit set of info or circumstances. No reader ought to act or chorus from appearing on the idea of any data offered herein with out searching for the recommendation of counsel within the related jurisdiction. Bend Legislation Group, PC expressly disclaims all legal responsibility in respect of any actions taken or not taken based mostly on any contents of this text.