The cap and the discount

An angel offers $250K on a SAFE “with a $5M cap and a 20% discount.” Many founders think that the angel gets two benefits: the cap price, and 20% off that price too. That is incorrect. The SAFE converts at one price, and the investor gets the price that buys more shares. This lesson shows how to find that price and when each term wins.

Two ways to a lower price

A SAFE investor takes a risk before the new investors in the priced round. Thus, the SAFE converts at a price that is lower than the round price, or at the same price in the worst case. A SAFE can give that lower price in two ways.

The first way is the valuation cap. The Safe Price is the price that the cap gives:

Safe Price = Post-money cap ÷ Company Capitalization

The second way is the discount. The Discount Price is a fixed part of the round price:

Discount Price = Round price × (1 − Discount)
$1.60          = $2.00       × (1 − 20%)

At $1.60, a $100,000 SAFE buys 62,500 shares. A new investor pays $2.00 and gets 50,000 shares for the same money. The SAFE gets 25% more shares.

The YC discount form does not write “20% discount.” It uses a “Discount Rate,” which is 100% minus the discount. Thus, a 20% discount is an 80% Discount Rate. YC writes that discounts are “commonly 10–20%.” WilmerHale writes that most discounts are 10% to 30%, usually in steps of 5%.

The investor gets the price that buys more shares

A SAFE with a cap and a discount does not add the two terms. It converts into the larger of two share counts. Thus, the SAFE converts at the lower of the two prices.

Here is the SAFE from the start of the lesson: $250K, a $5M post-money cap, and a 20% discount. The company has 10,000,000 other shares. With the SAFE at its cap, the Company Capitalization is 10,000,000 ÷ (1 − 5%) = 10,526,316 shares. The Safe Price is $5M ÷ 10,526,316 = $0.475.

At a high round price, the cap gives a much lower price. At a low round price, 80% of the round price can be less than the cap price. Then the discount wins.

The extra shares have a cost. At the $0.55 round price, a new investor’s $250K buys 454,545 shares. The discount gives the SAFE 568,182 shares, which is 113,637 more. Those extra shares come out of the founders and the other holders.

Predict first

A SAFE has a $0.475 Safe Price and a 20% discount. The round price is $0.55. At what price per share does the SAFE convert?

Type a guess before you continue. A guess first, even a wrong one, makes the answer easier to remember.

Your guessSave my guess

Where the two prices cross

The Safe Price stays the same when the round price changes. The discount price moves with the round price. Thus, the two prices are equal at one round price, the crossover:

Crossover round price = Safe Price ÷ (1 − Discount)
$0.59375              = $0.475     ÷ 0.80

Above $0.59375, the cap wins. Below it, the discount wins.

You can also find the crossover as a valuation. If the round adds no new option pool, the crossover pre-money valuation is the cap ÷ (1 − discount). For this SAFE, that is $5M ÷ 0.8 = $6.25M. WilmerHale gives an example with the same result. A SAFE has an $8M cap and a 20% discount. At a $10M pre-money valuation, the two terms give the SAFE the same shares.

Move the Series A price in the widget. Watch the ochre cap line and the gray discount line. The SAFE always pays the lower one.

Try it

Cap or discount: which price wins?

A SAFE with a cap and a discount converts at the lower of two prices. The company has 10,000,000 other shares before the round.

SAFE amount

Post-money valuation cap

Discount

Series A price per share

$1.20

Cap price

$0.475

$5M ÷ 10,526,316 shares

Discount price

$0.96

$1.20 × 80%

SAFE pays

$0.475

The cap wins

SAFE gets

526,316

2.53x the shares at the round price

• Round price
• Cap price
• Discount price

At a $1.20 round price, the discount gives $0.96, but the cap gives $0.475. The SAFE converts at the cap price and gets 526,316 shares, 2.53 times what $250K buys at the round price.

The discount price and the cap price cross at $0.5937. With no new option pool, that is a pre-money valuation of $6.25M, the cap ÷ 80%. This round price is a pre-money valuation of about $12.63M.

Look at the shares that the SAFE gets with a 20% discount. At the crossover, the cap and the discount give the same number. Above the crossover, the SAFE gets more than 1.25 times the shares that the round price buys. Below it, the SAFE gets exactly 1.25 times, because the discount sets the price.

A worked example below the crossover

The table above kept the Company Capitalization at 10,526,316 shares. That number assumes that the SAFE converts at its cap. The worked example shows what changes when the discount wins.

Worked example · step 1 of 5

A $250K SAFE at a $0.55 round price

1. 1

   Find the Safe Price

   Count the SAFE at its cap, as the YC form does. The SAFE is 5% of the Company Capitalization.

   Company Capitalization = 10,000,000 ÷ (1 − 5%) = 10,526,316
   Safe Price             = $5,000,000 ÷ 10,526,316 = $0.475

Show step 2Show all steps

The fourth step is a detail for experts. The result never changes: if the discount wins with the Safe Price at the cap, it also wins with the exact Safe Price.

Work it out

The Series A price is $2.00, and a SAFE has a 25% discount and no cap. What is the discount price?

Your answerCheck

Work it out

A SAFE has a $0.90 Safe Price and a 25% discount. The round price is $1.10. At what price does the SAFE convert?

Your answerCheck

Work it out

A SAFE has a $0.80 Safe Price and a 20% discount. At what round price do the cap and the discount give the same shares?

Your answerCheck

Read an offer with the two terms

An angel offers Northwind $500K at an $8M post-money cap and a 20% discount. Before you sign, find the crossover as a valuation. With no new pool, it is $8M ÷ 0.8 = $10M. That number tells you when the discount has any value:

• If the Series A pre-money valuation is more than $10M, the cap gives the lower price. The discount adds nothing.
• If the Series A pre-money valuation is less than $10M, the discount gives the lower price. The angel pays 80% of the round price.

If the company grows as planned, the Series A pre-money valuation is well above the cap. In that case, the discount costs the founders nothing. But a company that grows slowly can raise its next round near the cap or below it. In that round, the discount gives the angel 25% more shares than the new investors, and the founders pay for them.

A new pool in the round moves the crossover up, because the pre-money valuation must also pay for the pool. Use the SAFE conversion calculator to find the exact result for your own cap table.

Why did YC remove the form with a cap and a discount?

In the User Guide, YC wrote: “We did not encounter situations where the combo safe was the preferred choice.” A SAFE converts at only one of the two prices, so one of the two terms never has an effect in a given round. Investors who want the two terms use changed forms or other forms.

Which term is worth more

The two terms protect the investor in different rounds:

• The cap gives the investor a large reward when the company grows fast and the round price is much higher than the Safe Price.
• The discount gives a small, sure reward when the round price is near or below the Safe Price.

A SAFE with only a discount has no fixed percent. Its shares depend on the round price, so nobody knows its part of the company until the priced round. For this reason, most investors want a cap.

The discount reward has a fixed size. A 20% discount always buys 1 ÷ 0.8 = 1.25 times the shares that the same money buys at the round price. A cap has no such limit. In the table, at a $1.20 round price, the cap buys 526,316 shares. That is 2.53 times the 208,333 shares that $250K buys at the round price.

YC removed its form with a cap and a discount in 2021, but some investors still ask for the two terms, and some founders agree.

Quiz · question 1 of 5

Test what you learned

A SAFE has a cap and a 20% discount. How does it convert?

• AAlways at the discount price
• BAt the lower of the cap price and the discount price
• CAt the cap price minus 20%
• DAlways at the cap price