How do a discount and a valuation cap work together in a convertible?
By SuLe · Updated 23 June 2026
When a convertible has both a discount and a valuation cap, they don't stack — the investor typically converts at whichever of the two produces the lower price per share. The discount rewards early risk whatever the next round's valuation; the cap sets a maximum effective valuation, so it takes over once the round prices above a predictable crossover point.
Key facts
- With both mechanisms present, conversion typically happens at the lower of the discount price and the cap price — never both combined.
- UK convertible discounts typically run 10–20% on the next round's share price.
- The cap starts to bite once the round's pre-money valuation exceeds cap ÷ (1 − discount): £2.5m for a £2m cap with a 20% discount.
- For SEIS/EIS, what matters is meeting HMRC's ASA conditions — the discount and cap merely set the conversion price.
What does the discount do?
It prices the early investor's risk. A discount converts the instrument at a percentage off the share price paid by new investors at the qualifying round — typically 10–20% in UK deals.
If the next round prices at £2.00 per share and the instrument carries a 20% discount, the holder converts at £1.60. Whatever the valuation turns out to be, the early money pays less per share than the new money.
That "whatever the valuation" is also the discount's weakness: if the round prices spectacularly high, 20% off a huge number is still a huge number. Enter the cap.
What does the valuation cap do?
A cap fixes the maximum effective valuation at which the instrument converts. If the round values the company above the cap, the investor converts as if the valuation had been the cap, and their price per share scales down accordingly.
In per-share terms, the cap price is what a share would cost if the company were worth the cap: with 2,000,000 pre-round shares and a £2m cap, £1.00 per share — however high the round actually prices.
Caps were popularised by the US SAFE, where post-money variants are common, and they appear in UK ASAs and convertible loan notes too. Their job is to stop early conviction pricing the earliest investors out of the upside they funded.
Which price applies when you have both?
Typically whichever is lower. The investor does not take the discount off the cap price — the two are calculated separately and the instrument converts at the better (lower) of them.
So at conversion you run both sums. Discount price = round price × (1 − discount). Cap price = the per-share price implied by the cap. Convert at the lower, allot the shares, and file the SH01 within one month of allotment.
One caveat: this lower-of mechanic is the standard approach, but convertibles are contracts and drafting varies. Check that your document says "lower of" in terms — ambiguity about stacking is a conversion-day argument waiting to happen.
Where is the crossover point?
The cap starts mattering once the round's pre-money valuation exceeds cap ÷ (1 − discount). Below that line, the discount gives the lower price; above it, the cap does.
With a £2m cap and a 20% discount: £2m ÷ 0.8 = £2.5m. A round at £2.2m pre-money converts on the discount; a round at £4m converts on the cap; at exactly £2.5m the two prices coincide.
Model this before signing, not at conversion. The crossover tells you which valuations hand your convertible holders materially more shares — which is to say, what dilution you are actually agreeing to today.
Do the discount and cap affect SEIS or EIS?
Not in themselves. Relief turns on the instrument meeting HMRC's ASA conditions — irrevocable, non-refundable, interest-free, incapable of variation, converting only into full-risk ordinary shares, with a longstop no more than six months out — as set out in the advance assurance guidance.
The discount and cap simply set the conversion price. SEIS relief at 50% or EIS at 30% is then claimed on the amount invested, arising when the shares are issued at conversion — at whatever price applied.
A convertible loan note carrying identical pricing terms never qualifies, because it is debt.
| £50,000 convertible: 20% discount, £2m cap, 2,000,000 pre-round shares | Round at £4m pre-money (£2.00/share) | Round at £2.2m pre-money (£1.10/share) |
|---|---|---|
| Discount price (20% off) | £1.60 | £0.88 |
| Cap price (£2m ÷ 2,000,000 shares) | £1.00 | £1.00 |
| Conversion price — the lower of the two | £1.00 (cap wins) | £0.88 (discount wins) |
| Shares issued for the £50,000 | 50,000 | ~56,800 |
| Shares £50,000 of new money buys | 25,000 | ~45,500 |
Worked example
Jack and Wei, founders of a devtools startup, take a £50,000 ASA carrying a 20% discount and a £2m valuation cap; the company has 2,000,000 shares. Their seed round lands at £4m pre-money — £2.00 per share.
Two calculations follow. Discount price: £2.00 × 0.80 = £1.60. Cap price: £2m ÷ 2,000,000 shares = £1.00. The cap gives the lower price, so the investor converts at £1.00 and receives 50,000 shares — double the 25,000 that £50,000 buys at the round price. Had the round instead priced at £2.2m (£1.10 per share), the discount price of £0.88 would have beaten the £1.00 cap price, and the investor would have converted at £0.88 for about 56,800 shares.
Where founders go wrong
Stacking the discount on top of the cap
— they don't combine; conversion is typically at the lower of the two prices, and the document should say so in terms.Setting the cap without modelling dilution
— a low cap is a valuation in disguise. Count the shares that would be issued at the cap price before agreeing it.Ignoring the crossover point
— know the valuation at which the cap takes over (cap ÷ (1 − discount)) so neither side is surprised at conversion.Letting different investors hold different caps and discounts
— mismatched instruments multiply into cap-table friction when they all convert at the same round.
Related questions
Does the investor choose which of the discount or cap applies?
Usually no choice is needed: the instrument states that conversion happens at the lower of the discount price and the cap price, so the better outcome for the investor applies automatically. Read the clause, though — drafting varies, and ambiguity about stacking causes arguments at conversion.
What is a typical discount on a UK convertible?
Most UK ASAs and convertible notes carry a discount of around 10–20% on the price paid by new investors at the qualifying round. It compensates the early investor for risk taken before any valuation existed. A cap, where used, adds protection against the round pricing very high.
What happens if the next round prices below the cap?
Then the cap is irrelevant: the cap price would be higher than the discounted round price, so the discount gives the lower conversion price and applies instead. Caps only bite when the round values the company above the cap — more precisely, above cap divided by (1 minus discount).
Is a valuation cap the same as agreeing a valuation?
No — the cap is a ceiling for conversion pricing, not today's price: it matters only if the next round values the company above it. But a low cap can anchor the next round's negotiation, so set it with the same care you would a valuation. [More: What is a valuation cap and how does it work?]
A discount and a cap look like two small numbers in a short document, but together they decide how much of your company the early money takes at conversion — and the crossover maths surprises founders far more often than investors. A SuLe solicitor can model the terms against realistic round scenarios before you sign. Book a free term sheet review and see the dilution before you agree to it.
Keep reading: What is a valuation cap and how does it work? · What is an advance subscription agreement (ASA)? · ASA vs convertible loan note — what's the difference? · What is a down round and what does it trigger? · Pre-money vs post-money valuation — what's the difference?
Primary sources: HMRC — advance assurance for venture capital schemes · HMRC — Seed Enterprise Investment Scheme
