Latest / The Series A Show with Fexingo: Early-Stage Funding, Pitch Decks, and Startup Milestones / Why Founders Are Raising Convertible Notes With Revenue-Based Caps
Transcript
- Lucas: So I want to talk about a funding structure that's quietly becoming a favorite for founders who are tired of the standard SAFE or fixed-cap convertible note. It's the convertible note with a revenue-based cap. Luna: Revenue-based cap — meaning the valuation cap is tied to a multiple of revenue, not a fixed number? Lucas: Exactly. Instead of saying 'the cap is $10 million,' you say 'the cap is 8 times annual recurring revenue.' So if your ARR is $2 million, the cap is $16 million. If your ARR grows to $3 million by conversion, the cap adjusts to $24 million. Luna: That sounds founder-friendly in theory. But does it actually work in practice? I'd imagine investors push back on the multiple. Lucas: They do. But I found a good case study. There's a B2B SaaS startup called Portage — they do supply chain analytics. Last quarter they closed a $4.2 million convertible note with exactly this structure: an 8x ARR cap. The lead investor was a mid-sized VC that wanted downside protection but also wanted to reward growth. Luna: What was Portage's ARR at the time? Lucas: About $700,000. So the cap was effectively $5.6 million. But here's the clever part: the note also had a floor — a minimum cap of $4 million, so if ARR dropped, investors wouldn't get completely diluted. Luna: That feels like a compromise. Investors get a floor, founders get upside if they execute. Lucas: Right. And in this market — mid-2026 — where public comps are all over the place, it's a smart middle ground. Look at Tesla down 16 percent in five days. Palantir down almost 7 percent. Even Shopify dropped 9.4 percent. If public multiples are that volatile, how do you set a fixed private valuation cap? Luna: You can't. Or at least, you shouldn't pretend you can. I've seen startups set a $12 million fixed cap based on a comp from six months ago, and then the market shifts and the round doesn't convert. Lucas: Exactly. The revenue-based cap keeps the round alive because it adjusts with actual performance. If the startup grows into the cap, investors still get their discount. If it stalls, the floor protects them. Luna: So this is a way to de-risk the conversion for both sides. I can see why it's catching on. Lucas: And it's not just early-stage. I've seen later-stage bridge rounds using this too. It's a flexible instrument for uncertain times. Luna: If this episode is useful for what you're building or running, that's exactly why we do it. And the way we keep these conversations ad-free — no sponsors, no interruptions — is through listener support. If you've gotten value from today's angle, you can help keep it going at buy me a coffee dot com slash fexingo. That's it. No pressure, just a way to sustain the show. Lucas: Yeah, and it genuinely makes a difference. Every contribution goes straight into research and production. So thank you if you've ever chipped in. Luna: Alright, back to the cap structure. Lucas, you mentioned Portage — how did the rest of the terms look? Discount rate? Lucas: Standard 20 percent discount, maturity in 24 months, and no interest accrual. The note was uncapped in terms of the discount — meaning if the cap wasn't hit, investors still got 20 percent off the next round price. Pretty clean. Luna: No interest? That's unusual. Most convertible notes have a small interest rate, even if it's nominal. Lucas: True. But in this case, the investors traded interest for the floor. They wanted that downside guarantee more than a few basis points of interest. Luna: Makes sense. So the trade-off is clear: founders give up a bit of downside protection in exchange for more upside flexibility. Lucas: Right. And it signals to future investors that the company's valuation is grounded in real unit economics, not wishful thinking. Which is increasingly important as we see layoffs like Patreon cutting 20 percent of its workforce — that's a reminder that even established startups can overreach on valuation. Luna: Patreon's layoff was a shock. They were seen as a stable subscription business. Lucas: Exactly. And part of the reason was that their last round had a fixed cap that didn't match their actual growth trajectory. A revenue-based cap might have avoided that mismatch. Luna: So for a founder listening today — Q3 2026 — what's the key takeaway? Lucas: If you're raising a convertible note, consider proposing a revenue-based cap tied to a reasonable multiple — say 6x to 10x ARR, depending on your sector. It protects you from market whiplash and gives investors a clear, performance-based valuation. Luna: And if an investor pushes back, you can point to Portage's deal as a precedent. Lucas: Exactly. The structure is becoming standard enough that you can argue it's market. Just make sure your revenue metrics are auditable — because investors will check. Luna: Always. So next time you're negotiating a term sheet, ask yourself: is my cap fixed to a number, or fixed to reality? Lucas: Good way to put it. That's a wrap for this episode. We'll be back with another angle on early-stage funding next week.