What is a valuation cap and how does it work?
By SuLe · Updated 1 June 2026
A valuation cap is a ceiling on the company valuation used when a convertible investment (SAFE, ASA or loan note) converts into shares. However high your next round prices the company, the early investor's money converts as if the valuation were no more than the cap — so the better your round goes, the bigger their effective discount.
Key facts
- A valuation cap fixes the maximum valuation used to price a convertible's conversion — however high the next round goes.
- Cap and discount don't stack: the investor typically converts at whichever gives the lower price per share.
- UK ASA discounts typically run at 10–20%; post-money cap variants are common in US SAFEs.
- A cap does not by itself break HMRC's SEIS/EIS conditions — the danger terms are refunds, interest, variation rights and a longstop beyond six months.
How does a valuation cap work at conversion?
At your next round, the convertible converts at the lower of the round's real valuation and the cap. If the round prices the company above the cap, the early investor's shares are priced as if the company were worth only the cap.
The arithmetic is simple: conversion price = round share price × (cap ÷ round valuation), whenever the valuation exceeds the cap. Price a round at £6m against a £3m cap and the convertible converts at half the round's share price — a 50% effective discount.
If the round comes in at or below the cap, the cap does nothing: the investor converts at the round price, or at their discounted price if the instrument also carries a discount. A cap only ever helps the investor — it never hurts them.
How do a cap and a discount work together?
They don't stack. Where a convertible carries both, the investor typically converts at whichever of the two produces the lower price per share.
Think of the discount as the baseline reward and the cap as the upside kicker. In a modest round the discounted price is usually the lower one, so the discount governs; in a strong round the cap price undercuts the discount and takes over.
That switch is worth modelling before you sign, not after your round prices. Two or three scenarios — a soft round, an expected round, a great round — will show exactly how many shares each mechanism hands over.
| Structure | Conversion price | Effect |
|---|---|---|
| Discount only | Round price × (1 − discount) | Fixed reward, whatever the valuation |
| Cap only | Round price × (cap ÷ round valuation), when the round values the company above the cap | The reward grows as the round prices higher |
| Cap + discount | Whichever of the two prices is lower | Investor typically gets the better of the two — they don't stack |
Do UK ASAs use valuation caps?
They can — nothing in HMRC's published conditions prohibits a cap. UK ASAs price conversion with a discount, typically 10–20%, and a cap can sit alongside it.
HMRC's conditions for SEIS and EIS are about the character of the money, not the pricing formula: the payment must be irrevocable, non-refundable and interest-free, the agreement incapable of variation, and conversion must be into full-risk ordinary shares within a six-month longstop. A cap does not by itself offend any of that — but have the drafting checked against the advance assurance guidance, because relief is lost on detail.
An ASA also carries a number a SAFE lacks: the fallback valuation, which prices conversion at the longstop if no round arrives. Don't confuse the two — the cap limits a real round's price; the fallback substitutes for a missing one.
What should you weigh before agreeing a cap?
Dilution and signalling. The cap decides how much of the company your earliest money takes if things go well — and every future investor will read it as your own view of the company's value.
Model conversions at two or three plausible round valuations and look at share counts, not just percentages. A cap set low to close quickly keeps costing you: the better the round, the larger the effective discount it hands over.
If the template is American, check whether the cap is pre-money or post-money — post-money variants are common, and they count the convertible money itself inside the cap, concentrating the dilution on founders. And keep the ASA disciplines regardless: HMRC's conditions and the six-month longstop still apply if SEIS or EIS is in play.
Worked example
Daria, sole founder of a consumer savings app, raises £100,000 from an angel on an ASA with a 15% discount and a £2m valuation cap. Five months later — inside the six-month longstop — she closes a seed round at a £4m pre-money valuation, £1.20 per share.
The discount would price the angel's conversion at £1.02 (15% off £1.20). The cap prices it at £0.60, because £2m is half of £4m. The lower price wins: the ASA converts at £0.60, issuing 166,667 shares instead of the 98,039 the discount alone would have produced — an effective discount of 50% on the round price. Daria's strong round is exactly what made the cap expensive.
Where founders go wrong
Reading the cap as a valuation
— it is a conversion ceiling, not what your company is worth; but investors will treat it as an anchor in the next negotiation, so set it deliberately.Stacking the discount on top of the cap in the model
— they don't stack; the investor typically converts at whichever price is lower.Agreeing a low cap to close fast
— the better your round goes, the more shares the cap hands over; the dilution surfaces exactly when things are going well.Missing the post-money twist in US templates
— post-money caps count the convertible money inside the cap and push the extra dilution onto founders; know which variant you are signing.
Related questions
Is a valuation cap the same as an ASA's fallback valuation?
No, though both put a number in a convertible. A cap limits the valuation used when a round does happen; a fallback (longstop) valuation prices the conversion when no round happens in time. UK ASAs need the fallback for the longstop; a cap is optional. [More: Why do ASAs have a six-month longstop date?]
Do I have to offer both a discount and a cap?
No. A convertible can carry a discount alone, a cap alone, or both — UK ASA discounts typically run at 10–20%. If you offer both, remember the investor typically converts at the lower resulting price, so model each scenario before signing. [More: How do a discount and a valuation cap work together in a convertible?]
Does a valuation cap affect SEIS or EIS?
Not by itself. HMRC's published conditions are about the payment being irrevocable, non-refundable, interest-free and incapable of variation, converting into full-risk ordinary shares within a six-month longstop — not about how the conversion price is set. Still have the drafting checked: relief is lost on detail. [More: Do ASAs and convertible notes qualify for SEIS/EIS?]
What happens to the cap in a down round?
If the next round prices the company below the cap, the cap is simply irrelevant — the investor converts at the round price, or at the discounted price if there is a discount. A down round has other consequences, though, particularly for existing investors' anti-dilution rights. [More: What is a down round and what does it trigger?]
A cap is three lines in the agreement and often the single biggest driver of how much equity your earliest money takes. A SuLe solicitor can model your cap, discount and fallback numbers against realistic round outcomes — and check the SEIS/EIS drafting while they're at it. Book a free term sheet review before the terms go out.
Keep reading: How do a discount and a valuation cap work together in a convertible? · What is an advance subscription agreement (ASA)? · ASA vs SAFE — which should UK startups use? · What is a down round and what does it trigger? · What is a priced round vs a convertible round? · Pre-money vs post-money valuation — what's the difference?
Primary sources: HMRC — Seed Enterprise Investment Scheme · HMRC — advance assurance for venture capital schemes
