Pre-money valuation vs Post-money valuation – Understanding the difference

As an owner of a startup, you must have realized that it is not easy to run. There are many things you face, and to deal with them you need to have the necessary knowledge. Some terms that will keep coming up when you decide to raise funds through venture capital are pre-money and post-money valuation.

Whether you’re a founder looking to raise capital or an investor evaluating potential opportunities, grasping the distinction between these valuations is essential.

In this article, we explain definitions, calculations, and implications of pre-money and post-money valuations, equipping you with the necessary knowledge to navigate funding rounds.

Understanding Pre-Money Valuations vs. Post-Money Valuation

Pre-money valuation is the company’s worth, excluding the external or last round of funding. The best way to describe it is the net worth of a startup before it secures investments. Determining the value of a startup not only tells investors about the company’s worth, but they can also use it to derive the issued share price per share. This figure is pivotal for entrepreneurs as it sets the stage for negotiations, helping them gauge how much equity they might have to relinquish to secure funding.

On the other hand, post-money valuation is the startup’s worth after they secure investments. It includes the injection of capital from outside sources. It is essential to have adequate knowledge of both terms as they will regularly come up during negotiations with investors.

Adding cash to the company’s balance sheet increases the value of its equity. So, when compared, the post-money valuation always stays on the upper side. The difference between both is important as it defines the equity investors will get after the funding.

For example, Investor A gives the company capital of $500,000. If the company’s pre-money valuation is $2,000,000, they will receive 20% of equity shares.

If the company’s pre-money valuation is $1,500,000, then the equity received by Investor A will be 25%. This can have a dramatic implication on the company’s financials. The investors use the Startup pre-money and post-money valuation to determine the amount of equity they will receive once the funding is over.

Why is pre-money and post-money valuation important?

Calculating the valuation of a startup is essential to investors as it allows them to derive their investment value. They use it to determine future returns. Pre-money valuations help the investor derive the startup’s worth and the individual price of the issued share. The price of the shares is vital as it dictates the number of shares the investor gets.

Let’s take an example: The details of an investment made in XYZ Ltd is as follows:

The pre-money valuation of a business is $30 million; before investment, the number of issued shares is 1 million. You have all the required data to calculate the price of the issued shares.

If you are to invest $15 million, then to calculate the number of new shares to be issued, you will divide the amount by the share price.

When a startup is looking for funds from investors and venture capitalists in the future, the first thing they usually look at is if the current pre-money valuation is higher when compared to the last post-money valuation. If it is higher, it means that your company has grown since the previous investment. If in any case, it is lower, then it will be called a down round. It is ideal for a company to have an up round. This shows that your business is growing. Investors also prefer a company that has an up round.

Calculating pre-money valuation and post-money valuation

The pre-money valuation is the startup’s worth before any funding. It presents a picture to the investor showing the present value of the company. Calculating it is not a difficult task, here is how to do it:

If an investment is made in a startup worth $9 million and the investor gets 10% equity in exchange, the post-money value is $90 million. The pre-money valuation: $90 million – $9 million = $81 million. You should subtract the money invested to show the company’s initial value.

When it comes to the post-money valuation of a business, it is much simpler to calculate than the pre-money value of a business.

Using the above example, If the investment was worth $9 million for 10%, then the post-money valuation:

This does not mean that the accurate value of the company is $90 million. Factors such as an increase in cash in the balance sheet can increase the value by the same amount.

How pre-money valuation influences future investment rounds?

Using the formula PPS= pre-money valuation / fully diluted capitalization, the price per share is derived. This is the amount that an investor will pay for the shares of your company. The PPS and pre-money are proportional; if one rises, so does the other. An investor will pay a higher price for each share if its valuation is higher. The investor will receive a lower number of shares for the same amount of investment.

Let us use an example to understand this better. Xtra Inc has a pre-money valuation of $4 million. Investor A invests $1 million into the company. Xtra Inc has to issue shares to the investor. The company’s value was $5 million / $4 million = $1 per share before receiving the funds. When the company receives the fund invested, it will issue new shares. The number of shares will be derived by dividing the investment amount by pre-money price per share.

The number of shares the investor will get: $1,000,000 / $1 = 100,000 shares. The total number of shares now is 1,100,000, the founders own 90.1% of the company, and the investor owns 9.09%.

If the company continues to operate and run well eventually, it will require additional capital. Now Investor B, a new investor, decides to invest $3 million at the post-money valuation of $10 million. This means the pre valuation this investor is considering is $7 million.

Here we will use the above details to derive the price per share: $7 million / 1,100,000 = $6.36 before the investment. Now the company will issue: $3,000,000 / 1,100,000 = 471,698 new shares to the investor. The company now has 1,571,698 shares, from which the owners own 1 million shares. But it represents 63.6% of the company’s total shares, which is lower than the previous 90.1% they had.

Whenever the company raises capital, it drops the percentage of ownership of the founders. This drop-in ownership is called dilution. For the dilution to have a lower impact on the owners, they need to participate in the funding rounds. One thing to keep in mind is that there are times that owners’ key concerns are the dilution of ownership and pre-money valuation. But there are cases where just owning 15% of a big tech company is more profitable to an investor when compared to owning 25% of a small tech company. This is because founders can’t build a tech company that big without investors.

Key Difference in Pre-Money Valuation and Post-Money Valuation

From the previous sections, it is evident that these concepts are crucial in the context of startup financing, especially venture capital. To clarify the understanding of both  we have compiled the details into the table below.

Pre-money and post-money valuations have important roles in determining equity distribution during investment rounds. They affect how much ownership founders retain and how much investors receive, it influences long-term control and financial outcomes for owners and investors. Understanding these valuations is essential for effective negotiation and strategic planning in startup financing.

Choose Eqvista to Empower Your Startup’s Growth with Precise Valuations!

Pre-money and post-money valuations are crucial for the investment landscape for startups. They show company worth and future growth potentials, investor relationships, and overall growth strategy. Understanding these enables entrepreneurs to make decisions that align with their long-term goals while effectively managing equity distribution during funding rounds.

Eqvista provides essential tools and services that enable companies to effectively manage their pre-money and post-money valuations, ensuring they are well-prepared for fundraising activities while maintaining compliance with regulatory standards. Eqvista tools use all supported and beneficial methods for a wide range of businesses and different situations. Use our 409a valuation services to value your company today!