By Doug Bend, founding father of Bend Law Group, PC, a legislation agency centered on small companies and startups.
We now have helped dozens of startups increase their seed spherical of financing. Most of those firms have used the template Easy Settlement for Future Fairness (higher referred to as a SAFE) with a valuation cap that Y Combinator has open-sourced here.
Among the finest attributes of the SAFE is the S, which stands for “easy” as a result of only some phrases usually have to be negotiated with an investor. This helps to lower the period of time that the founders and the corporate’s lawyer must spend on negotiating phrases.
Crucial of those is commonly the valuation cap, which gives 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, gives 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 ground possession share 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 usually six key elements—let’s check out them.
1. The General Fundraising Market
The primary issue is the general fundraising setting 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.
2. Traction
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 consumer and income progress. For instance, traders usually tend to put money into an early-stage startup if it has not less than 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 prone to have a better valuation cap.
Traders usually tend to make investments with a better valuation cap if the founder has beforehand supplied the investor with a stable return. If the founder has carried out it earlier than, they’re extra prone to do it once more.
4. The Expertise Of The Founders
Founders are prone to have a better valuation cap if they’ve expertise that’s related to the startup, notably 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 additionally if the suitable group is implementing that concept.
5. Business
The business the startup is in also can affect the valuation cap for the SAFE. For instance, software program firms typically have a better valuation cap as a result of they will shortly develop and scale.
6. Leverage
Lastly, the valuation cap will possible be greater the extra leverage the startup has. For instance, the extra curiosity there may be 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 may use that as leverage to barter a decrease valuation cap or not make investments in any respect in the event that they consider the startup just isn’t as prone to be financially solvent.
As you’ll be able to see, the valuation cap for a startup’s seed spherical is predicated on a number of variables. Founders are greatest served working with their firm’s CPA and lawyer to gauge what valuation cap quantity is market and honest for each their firm and its traders.
Disclaimer: This text discusses basic authorized points and developments. Such supplies are for informational functions solely and will not replicate probably the most present legislation in your jurisdiction. These informational supplies will not be supposed, and shouldn’t be taken, as authorized recommendation on any specific set of information or circumstances. No reader ought to act or chorus from appearing on the idea of any info offered herein with out in search of the recommendation of counsel within the related jurisdiction. Bend Regulation Group, PC expressly disclaims all legal responsibility in respect of any actions taken or not taken based mostly on any contents of this text.