Startup Funding Glossary

Pre-money and post-money valuation

Pre-money valuation is what the company is valued at before new capital is invested. Post-money is pre-money plus the new investment. A $5M check at $20M pre-money is a $25M post-money round; the new investor owns 5/25 = 20%. The same $5M check at $20M post-money values the company at $15M pre-money and gives the investor 25%. The five-million-dollar difference between $20M pre and $20M post sounds small but represents 5% of the company, which can be tens of millions of dollars at exit.

Confusion between pre and post is the most common founder negotiation error. Always confirm in writing whether quoted valuations are pre or post, and note the option pool treatment, which can shift dilution by another 5-15% on top.

SAFE (Simple Agreement for Future Equity)

A SAFE is a convertible instrument introduced by Y Combinator in 2013 to replace convertible notes for early-stage funding. The investor wires money now and gets equity at the next priced round, on better terms than the new investors. The two key terms are the valuation cap (a ceiling on the conversion valuation) and the discount (a percentage off the round price). Unlike a convertible note, a SAFE has no maturity date and no interest — it's not debt.

The original SAFE was pre-money; the 2018 update is post-money. Post-money SAFEs make ownership predictable up-front (the cap is on the post-money including all SAFEs), but typically dilute founders more. See the SAFE conversion calculator.

Convertible note

A convertible note predates the SAFE and serves a similar function: bridge capital that converts to equity at the next priced round. Differences from SAFEs: the note is debt, accrues interest (typically 4-8% annually), has a maturity date (typically 18-24 months), and may convert to a default conversion price or trigger repayment if no qualified round occurs by maturity. The interest accumulates and converts into additional shares, increasing dilution beyond the explicit principal.

Convertible notes are still common in some markets and in bridge financings between rounds. Their main complication is the maturity date — if the priced round doesn't happen in time, founders and noteholders need to renegotiate, which is a stressful conversation in a tight cash position.

Valuation cap

A valuation cap protects early investors from being penalized for being early. If a SAFE has a $10M cap and the next round prices at $40M, the SAFE converts as if the company were valued at $10M — meaning the investor gets 4× the shares they would have at the round price. Without the cap, an early investor in a successful company would own less than later investors who took less risk.

The cap is the most-negotiated SAFE term. Founders want a high cap (less dilution); investors want a low cap (more upside). Common ranges: $4-8M post-money for pre-seed, $8-15M for seed, higher for later rounds. SAFEs without caps exist but are rare and usually require unusual investor confidence in the founder.

Discount

A discount gives the SAFE or note holder a price below the next round's price — typically 10-25%. If the round prices at $2/share with a 20% discount, the SAFE converts at $1.60. The discount is the lower-impact of the two SAFE protections (cap and discount); the cap usually controls when the round prices well above it. Some SAFEs have a discount only, no cap; this is friendlier to founders but only protects investors against priced rounds materially higher than the SAFE wire date.

409A valuation

A 409A valuation is an independent assessment of the fair market value of a company's common stock, required by US tax code Section 409A whenever the company grants stock options. Setting the strike price below the 409A FMV creates immediate taxable income for the employee and triggers severe tax penalties. Most startups commission a new 409A every 12 months or after any material event (priced round, large customer, leadership change).

The 409A FMV is typically meaningfully lower than the preferred share price (often 30-60% lower for early-stage companies), reflecting common stock's lack of preferences and liquidity. This gap is what allows employee options to have intrinsic value: the strike (set at 409A FMV) is below what investors would pay for preferred shares.

Liquidation preference

A liquidation preference gives preferred shareholders a defined return on their investment before common shareholders (typically founders and employees) receive anything. Standard term: 1× non-participating — investors get their money back first, then choose between keeping that or converting to common to share in the upside. "Participating preferred" gives the investor both the preference and a share of the remaining proceeds — much worse for common holders.

Liquidation preferences matter most in down-side scenarios. In a $30M acquisition, $20M of 1× non-participating preferred takes $20M off the top, leaving $10M for common. In a $200M exit, the same preferred would convert to common (because pro-rata participation is more than $20M) and the preference is irrelevant. Multiples (2×, 3× preferences) get used in distressed financings and almost always destroy value for common holders.

Pro rata rights

Pro rata rights allow an existing investor to participate in future rounds at the same proportion as their current ownership, preventing dilution. A 10% investor with pro rata rights can buy 10% of any new round. This protects investors from being squeezed out by larger funds in later rounds — important for early-stage investors whose position would otherwise dilute heavily through Series B, C, D.

Founders sometimes resist granting pro rata to small investors because it complicates later rounds (more signature collection, more cap table noise). Standard practice is to grant pro rata only to "major investors" above a threshold ($250K, $500K, or 1% ownership are common cutoffs). Major-investor-only pro rata is widely accepted; eliminating pro rata entirely is unusual.

Anti-dilution provisions

If a company raises a "down round" — a new round at a lower per-share price than the prior round — anti-dilution provisions adjust the conversion ratio of the earlier preferred shares to compensate. The two main flavors: full ratchet (earlier preferred converts as if originally bought at the new low price — extremely punitive to common) and weighted average (a weighted formula that's much friendlier; broad-based weighted average is the most common). Almost all standard NVCA term sheets use broad-based weighted average.

Anti-dilution doesn't trigger in flat or up rounds; it only matters when valuations decline. In a down market it can be severe — full ratchet can dilute founders to single-digit ownership. Weighted average is moderate but still meaningful. The provision encourages founders to avoid down rounds even when accepting one would be the right strategic choice.

Drag-along and tag-along rights

Drag-along rights (sometimes called "bring-along") allow majority shareholders (or a defined supermajority) to force minority shareholders to participate in a sale of the company on the same terms. Without drag-along, a holdout minority can block an acquisition. Drag is essential for clean exits.

Tag-along rights (or "co-sale") work the opposite direction: if a major shareholder (typically a founder) sells some of their stock to a third party, minority holders have the right to participate in the same sale on the same terms. Tag-along prevents founders from cashing out without giving investors the same opportunity. Both rights show up in standard preferred stock financings.

Pay-to-play

Pay-to-play provisions force existing preferred shareholders to participate in subsequent rounds (typically pro rata) or face conversion of some or all of their preferred shares to common. The penalty disincentivizes free-riding by early investors who want to keep their preference without supporting later rounds.

Pay-to-play is uncommon in healthy markets but appears more often in down rounds, where the company needs every existing investor to lean in. Strong pay-to-play (full conversion to common) is severe; partial pay-to-play (loss of anti-dilution, loss of pro rata) is more common. Founders rarely propose pay-to-play; lead investors of bridge or down rounds insist on it as a condition of the new money.