We are first time entrepreneurs and have a pre-revenue tech startup. We’re currently raising our first round of funding (pre-seed you could call it), and we’ve received some decent interest. A VC wants to know what cap we are raising at. What does this mean and how would we know? Additional information: We have a prototype and we are not incorporated.
Congrats on getting the ball rolling with your business — and generating some interest from potential customers and investors.
As to your question, when a potential investor asks about your cap, they’re referring to the valuation cap you’re setting on your convertible debt issue. That would be the maximum valuation at which this issue would be converted into equity when its term expires.
Frankly, if you aren’t even incorporated yet you might want to pause the fundraising and focus on firming up your company’s foundation. You’re off to a great start but there’s a lot more to building a business than a prototype and some cash from a VC type.
If you wish to discuss, send me a PM through Clarity for 15 free minutes.
"Cap" is applicable only if you are raising via a convertible note. If you are doing an equity round (issuing new stock (called a primary, is most normal) or selling existing stock (called a secondary) then you wouldn't talk about a cap but a "valuation" instead (pre or post money).
In that context a cap is short for a valuation cap, meaning the highest possible valuation that will be used to calculate the conversion of the note to stock during the next fundraise in which stock is issued.
A note is like a promise to give you stock in the future in exchange for your money now.
Hi, first off--congratulations on starting to get some VC interest. I've been through this process when raising for my own startup. I currently help founders at a global startup company-builder. I hope the following helps.
"Cap" is used to denote the maximum valuation you will use as ceiling in a convertible debt (CD) transaction. Don't let the name worry you, it isn't a loan that needs to be paid back. When raising money for a very early startup, there's no precedence for you to determine what valuation the startup commands. So, you'd rather defer that valuation decision to a point where you have more traction and you can be more scientific about how much your company is worth. In a CD arrangement, investors will commit to investing in your company for a "discount" on your next equity raise. If your next round is at a $2m valuation and you offered them a 20% discount, then -- when you raise your next equity round -- they'd receive shares at a $2m minus 20% valuation.
Happy to share more details on this, and help understand how to determine the right terms for your team. And address any questions you may have.