SAFE Cap vs Discount vs MFN: The Complete Founder's Guide

If you're raising early-stage capital today, you're likely facing a critical decision: which SAFE structure should you use?

A valuation cap, a discount rate, or Most Favored Nation terms. Each mechanism creates different outcomes for you and your investors. Choose wrong, and you could face unexpected dilution or struggle to close your next round.

This guide breaks down exactly how each mechanism works, when to use them, and how to negotiate terms that set you up for long-term success.

What is a SAFE?

A Simple Agreement for Future Equity (SAFE) is a contractual agreement between a startup and an investor that gives the investor the right to receive equity during a future priced funding round.

Created by Y Combinator in 2013, SAFEs have become the dominant instrument for early-stage funding, now accounting for 90% of pre-seed rounds and 64% of seed rounds.

Unlike convertible notes, SAFEs are not debt instruments. They don't accrue interest, have no maturity date, and carry no repayment obligation. This makes them faster to execute, cheaper to implement, and significantly more founder-friendly than traditional convertible notes.

When SAFEs convert to equity

SAFEs automatically convert into preferred stock when an Equity Financing occurs, which is defined as a bona fide transaction with the principal purpose of raising capital where the company issues and sells Preferred Stock at a fixed valuation.

SAFEs also convert during Liquidity Events (acquisition, IPO, direct listing) or Dissolution Events (company shutdown). In these scenarios, SAFE holders receive proceeds based on the greater of their original investment or what they would receive if converted to Common Stock.

The three core SAFE mechanisms

When you issue a SAFE, you need to decide which mechanism(s) will determine how your investor converts their investment into equity:

• Valuation Cap sets a maximum company valuation for conversion purposes

• The Discount Rate gives investors a percentage discount off the next round's price

• Most Favored Nation (MFN) allows investors to adopt better terms from future SAFEs
  

Each mechanism serves a different purpose and creates different incentive structures. Understanding these differences is critical to structuring your fundraiser correctly.

Valuation cap: Protecting early believers

What is a valuation cap?

A valuation cap sets a ceiling on your company's value for the purpose of converting the SAFE into equity. It's the maximum valuation at which the SAFE investor's money will convert, regardless of how high your actual next round valuation goes.

Here's the critical understanding: A valuation cap is NOT your company's current valuation. It's a conversion ceiling that determines the price per share your SAFE investor will pay when they convert.

How the valuation cap works

When your next priced round happens, the investor always gets the better deal. They convert at whichever valuation is lower: the cap or the actual round valuation.

If the round valuation is higher than the cap, the SAFE investor converts at the cap, getting a lower price per share (and therefore more shares) than the new round investors.

If the round valuation is lower than the cap, the SAFE investor converts at the actual round valuation, getting the same price per share as new investors.

The cap protects early investors from excessive dilution when your company succeeds dramatically.

Post-money vs pre-money caps

Post-money SAFEs, now the industry standard at 85 to 87% usage, calculate investor ownership based on the company's capitalization after the SAFE investment is factored in. This provides founders with much clearer upfront visibility into dilution.

Pre-money SAFEs, now rare, calculate ownership based on the valuation before new capital is added, which can obscure the true dilution impact.

Always use post-money SAFEs. The clarity is worth it, and investors now expect them as standard.

Setting the right valuation cap

The cap typically reflects a negotiated estimate of your company's current value, with consideration for several factors. Stage and traction matter: pre-seed might be $5 to 8M cap, seed might be $10 to 20M cap. Market conditions play a role, with hot markets commanding higher caps. Founder leverage matters too. Serial entrepreneurs or competitive rounds get better terms. Your expected next round is important as well, since the cap should be significantly below your anticipated Series A valuation. Geography also factors in, with Silicon Valley caps tending to be higher than other regions.

While convertible instruments are marketed as "deferring valuation," using a cap means you're still having a valuation discussion. The cap requires both parties to agree on an implied company value.

Why sophisticated investors insist on caps

Uncapped SAFEs create misalignment. The founder's incentive is to get the highest possible next-round valuation. But with an uncapped SAFE, the investor's incentive is actually to hope for a lower next-round valuation to get more shares.

This directly opposes the alignment you want between founders and early supporters.

Sophisticated institutional investors typically refuse uncapped SAFEs. According to recent data, only about 1% of SAFEs have neither a cap nor a discount, and many of these likely involve inexperienced investors or very specific circumstances like bridge rounds with existing investors.

Valuation cap calculation example

Let's say you raise $500,000 on a SAFE with a $10M post-money cap. Your Series A happens at a $30M pre-money valuation, and Series A investors pay $5.00 per share.

Without a cap, your SAFE investor would convert at $5.00 per share, getting 100,000 shares.

With the $10M cap, your SAFE investor converts at a much lower effective price. The cap means they're buying at a $10M valuation instead of $30M. This gives them roughly 3x more shares than they would have gotten without the cap.

Discount rate: The conversion confusion

What is a discount rate?

A discount rate gives investors the right to convert their investment at a percentage reduction off the price per share paid by investors in the next priced round.

The discount rate confusion

This is the number one documentation error founders make with SAFEs.

The SAFE form uses "Discount Rate" to mean the price after the discount is applied, not the discount percentage itself.

If you want to give a 20% discount, investors should pay 80% of the next round price. Therefore, you enter 80% in the "Discount Rate" field, not 20%.

Here's the correct interpretation: 20% discount means enter 80% as Discount Rate. 15% discount means enter 85% as Discount Rate. 25% discount means enter 75% as Discount Rate.

How discounts work

When your priced round happens, your SAFE investor converts at a discount price calculated as the Discount Rate multiplied by the Standard Preferred Stock price per share.

For example, if the Series A price per share is $2.00 and your SAFE has an 80% Discount Rate (20% discount), the SAFE investor conversion price is $2.00 times 0.80, which equals $1.60 per share. This means they get 25% more shares than Series A investors for the same investment amount.

Standard discount ranges

Market norms show 10 to 15% discount is conservative, often for later-stage bridges. 20% discount is the most common standard (entered as 80% Discount Rate). A 25 to 30% discount is aggressive early-stage terms, and less common.

Discounts don't compound over time in standard SAFEs. The discount applies once, at conversion, regardless of how long it takes to reach a priced round.

When to use discount-only SAFEs

Discount-only SAFEs (no cap) represent about 8% of the market according to 2024 Carta data.

Appropriate scenarios include bridge financing, where you need short-term funding between priced rounds and the valuation is about to be established. Insider rounds work well with discount-only terms, where existing investors are adding more capital and don't want to influence the next valuation. Hot companies with strong leverage can sometimes offer discount-only terms. Lower dollar amounts also make sense, where smaller angel investments involve investors who accept simpler terms.

Advantages of discount-only SAFEs include giving founders more flexibility in setting next round valuation. They're simpler to explain and calculate, and they avoid the valuation discussion entirely.

Disadvantages include the fact that most sophisticated investors won't accept discount-only terms. They provide less downside protection for investors and can severely dilute early investors if the next round is at a very high valuation.

Discount calculation example

You raise $250,000 on a discount-only SAFE with an 80% Discount Rate (20% discount).

Your Series A has a $20M pre-money valuation, $5M new investment, $25M post-money valuation, and a price per share of $4.00.

The SAFE investor conversion price is $4.00 times 0.80, which equals $3.20 per share. They receive $250,000 divided by $3.20, which is 78,125 shares.

Series A investors get $250,000 divided by $4.00, which equals 62,500 shares.

The discount gives them 25% more shares, or 15,625 additional shares.

Most Favored Nation (MFN) clause: The protective provision

What is an MFN clause?

A Most Favored Nation clause is a protective provision that guarantees that if you issue subsequent convertible securities with better terms, the original investor can choose to adopt those improved terms instead of their original SAFE terms.

MFN-only SAFEs (with neither cap nor discount) are the rarest type, used in very specific circumstances.

How MFN works

The trigger occurs when you issue a new SAFE (a "Subsequent Convertible Security") with more favorable terms. Favorable terms might include a lower valuation cap, a higher discount (lower Discount Rate), better liquidation preferences, or additional investor rights.

The MFN holder can elect to convert using either their original SAFE terms or the better terms from the new SAFE. If no better terms are issued, the MFN SAFE converts into Standard Preferred Stock at the lowest price per share in the Equity Financing.

When MFN clauses are used

Very early investors, like friends, family, or first angels who invest before you have any traction might get MFN as protection since you can't reasonably set a cap yet.

Strategic investors such as advisors or strategic partners who provide value beyond capital, might negotiate MFN to ensure they're not disadvantaged by later investors.

Y Combinator uses MFN on the larger portion of their investment, which we'll explore in detail later.

The problems with MFN clauses

MFN clauses limit your fundraising flexibility in several ways. Future investors may hesitate if existing MFN holders can cherry-pick their terms. If multiple early investors have MFN, a single new deal with better terms could trigger multiple conversions at favorable rates. Broadly written MFN clauses can be vague about exactly which terms are covered. You may need to notify and coordinate with all MFN holders before closing new deals.

Why MFN-only SAFEs are rare

According to market data, MFN-only SAFEs (with no cap or discount) are extremely uncommon for several reasons. Investors prefer certainty: a cap or discount provides a defined benefit, while MFN depends on future events. Without a cap, the same misalignment issue as uncapped SAFEs exists. Experienced investors want concrete terms upfront.

Only about 1% of SAFEs lack both cap and discount, and not all of these have MFN. Some are simply poor negotiations or involve inexperienced parties.

MFN best practices

If you must include an MFN clause, limit the scope by specifying it applies only to valuation cap and discount, not all terms. Set an expiration so MFN expires after a certain timeframe or event. Restrict by size, where MFN might only trigger for investments of similar or smaller amounts. Narrow the definition by clearly defining what constitutes a "Subsequent Convertible Security." Avoid perpetual blanket MFN, as overly broad clauses can create catastrophic complications.

Cap vs discount: Which should you use?

This is the most common strategic question founders face when structuring SAFEs.

The strategic differences

Valuation caps guarantee economic benefit regardless of next round valuation. They require negotiating an implied current value and shield investors from dilution in high-growth scenarios. Sophisticated investors typically insist on caps.

Discounts offer a simple percentage benefit that scales with next round price. They avoid formal valuation discussion and give founders more room to negotiate next round valuation. However, they may signal an earlier stage or less established company.

When to use cap-only (61% of SAFEs)

Cap-only SAFEs are the market standard for good reason.

Use cap-only when raising from institutional investors or experienced angels. Use them when your company has meaningful traction and can justify a valuation estimate. They work well when you're confident the next round will be at a significantly higher valuation. They're ideal when you want clear, predictable dilution modeling or when investors are focused on downside protection in high-growth scenarios.

Advantages include aligned incentives where both parties want high next-round valuation. They provide clear conversion expectations and meet investor expectations for serious early-stage deals. They're easier to model and track on cap tables.

Disadvantages include requiring agreement on an implied valuation now. They can create surprises if you don't model dilution carefully and provide less flexibility in next round valuation negotiations.

When to use discount-only (8% of SAFEs)

Use discount-only when raising a bridge round between priced rounds. They work when investors are existing insiders who don't want to set valuation. If you have extraordinary leverage (like being a serial entrepreneur), discount-only makes sense. They're appropriate when the investment is smaller and investors accept simpler terms or when the timeline to next priced round is very short.

Advantages include completely avoiding valuation discussion and giving founders maximum flexibility on next round. They're simpler to explain and calculate and appropriate for certain strategic scenarios.

Disadvantages include the fact that most sophisticated investors won't accept them. They create misalignment where investors want lower next round valuation. They provide less protection for investors in high-growth scenarios and can be severely dilutive to early investors if next round is very high.

Decision framework

Ask yourself these questions to guide your decision.

Who are your investors? Sophisticated institutions require caps. Friends, family, and early angels might accept discounts. Strategic partners need terms negotiated based on value.

What's your leverage? High demand or competitive rounds mean you choose. First-time founders without traction typically defer to investor preference.

How confident are you in growth? If you're expecting massive growth, caps are fair to early believers. If the trajectory is uncertain, discounts provide flexibility.

What's your timeline? Long runway to next round means caps provide certainty. Bridge to imminent priced round means discounts work fine.

Cap and discount combined: The controversial combo

Historically, some SAFEs included both a cap and a discount. This was once common but is now increasingly rare and controversial.

How cap plus discount works

When both are included, the investor converts using whichever mechanism gives them the lower price per share (the better deal).

The investor gets conversion at the cap, or conversion at the discount, or if neither helps, standard priced round terms. They automatically get the best option.

Why Y Combinator removed it

In 2021, Y Combinator removed the cap plus discount SAFE template from their standard offerings, arguing that one mechanism is sufficient to fairly reward early investors for their risk. Combining both is often punitive and creates misalignment. Stacking protections can lead to unexpected dilution for founders.

Y Combinator's standard deal explained

Y Combinator's investment structure provides a fascinating real-world example of how caps, discounts, and MFN can be strategically combined.

The YC investment structure

Y Combinator invests $500,000 total in each company, structured as two separate SAFEs.

SAFE number one is $125,000 for 7% equity. It's a post-money SAFE that implies a $1.785M valuation cap ($125K divided by 7% equals approximately $1.785M). The terms are non-negotiable and follow a standard cap-only structure.

SAFE number two is $375,000 with MFN. It's an uncapped SAFE with a Most Favored Nation provision that converts at the rate of the best deal you give anyone else. This creates a strategic incentive structure.

Why is this structure brilliant

The small cap-only SAFE ($125K for 7%) establishes a baseline investment that guarantees YC a minimum ownership stake. It provides clear, predictable conversion and is take-it-or-leave-it (founders can't negotiate).

The large MFN SAFE ($375K uncapped) creates powerful incentives. It discourages low-valuation deals: if you raise your next round at a low valuation, both the new investment and the $375K MFN safe convert at that low rate, causing massive dilution. It encourages patience: founders have strong incentive to wait and build value before raising, achieving a higher valuation that makes both SAFEs convert favorably. It aligns interests: YC wants you to build value and raise at high valuations, which benefits everyone. It provides flexibility: if you can command great terms from others, YC benefits alongside you via MFN.

The anti-abuse protection

Common question: Can't I just have a friend invest $1 at a $1 billion valuation to make the MFN safe convert favorably?

No, because of the "Equity Financing" definition. An Equity Financing must be a "bona fide transaction with the principal purpose of raising capital." A $1 investment is not a bona fide capital raise. It's an attempted manipulation that wouldn't trigger the MFN conversion. You need a real, substantial funding round.

Modeling YC's dilution impact

Let's model YC's total dilution under different scenarios.

In scenario A, you raise Series A at $10M pre-money. SAFE number one ($125K for 7%) converts to 7% ownership as stated. SAFE number two ($375K MFN) converts at whatever cap or discount the Series A investors get. If Series A is $2.00 per share with no special terms, $375K divided by $2.00 equals 187,500 shares. This represents another 5 to 6% dilution. Total YC ownership is approximately 12 to 13%.

In scenario B, you raise Series A at $30M pre-money. SAFE number one ($125K cap at $1.785M) converts at much lower price, so YC maintains approximately 7%. SAFE number two ($375K MFN) converts at Series A terms with higher price per share. This is much less dilutive to founders. Total YC ownership is approximately 8 to 10%.

The structure rewards both parties for building a valuable company.

Key takeaways from YC's deal

The two-tiered approach combines certainty (cap-only) with flexibility (MFN). MFN can be strategic when used by sophisticated investors who add massive value. Size matters: the MFN works because $375K is substantial enough to create real incentives. The non-negotiable baseline ensures YC's minimum return while allowing upside.

This is a unique situation: YC adds enormous value beyond capital (network, brand, guidance), justifying unique terms. Don't blindly copy this structure unless you're providing YC-level value beyond capital.

Building your SAFE strategy

Now that you understand the mechanics, let's build your approach.

For pre-seed founders

If you're raising your first capital without meaningful traction, consider using cap-only SAFEs with realistic caps. Pre-seed caps typically range from $5M to $8M, depending on market conditions and geography.

Avoid giving MFN unless absolutely necessary. Even in pre-seed, sophisticated angels will expect and accept cap-only terms if you're raising from quality investors.

For seed-stage founders

At seed stage, you likely have some traction and can justify a higher cap. Seed caps typically range from $10M to $20M.

Cap-only remains the standard. If you're doing a bridge round between your seed and Series A, consider discount-only terms since your priced round is imminent.

For bridge rounds

Bridge financing between priced rounds is an ideal use case for discount-only SAFEs. Since you're raising specifically to extend runway to a priced round that's 3 to 6 months away, the discount provides a fair reward without requiring a new valuation discussion.

You might also use the same cap as your previous round or a slightly higher cap to reflect progress.

Using Y Combinator's templates

Always use Y Combinator's standard templates unless you have a compelling reason to customize. The YC SAFE is the industry standard, well-tested legally, understood by investors, and free to use.

Customization usually just adds cost and complexity. Negotiate the economic terms (cap, discount) but keep the legal language standard.

Post-money is the new standard

Post-money SAFEs now represent 85 to 87% of the market. They calculate ownership based on the company's fully diluted capitalization after accounting for the SAFE investment. This provides clear visibility into dilution.

Pre-money SAFEs calculate ownership based on valuation before the new capital, which can obscure true dilution impact. Always use post-money SAFEs for clarity. Don't mix post-money and pre-money SAFEs in the same round as it creates unnecessary complexity and confusion.

Different caps for different investors

It's common and acceptable to have different caps for different SAFE investors. Earlier SAFEs often have lower caps (friends and family at $6M), while later SAFEs have higher caps (institutional angels at $12M). You might also offer different caps for different investor contributions or value.

Just track them all carefully on your cap table and be prepared to explain your rationale if questioned by future investors.

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