Pre-money valuation vs Post-money valuation – Understanding the difference
Pre-money and post-money valuation is one of the main focus of discussion in any venture investment.
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. You need to understand these terms in depth because this will have a massive impact on your business.
Pre-Money Valuations vs. Post-Money Valuation
Pre-money and post-money valuation is one of the main focus of discussion in any venture investment. The pre and post-money valuation of startups can be drafted in terms of sheets or calculations and capitalization tables. The reason why these terms come up during financing rounds is because they play a major role in determining the value of a deal. Valuation of your startup is essential as it can be used as a negotiation point. This will determine the value an investor will pay for a part of the company that you are willing to let go. The pre-money and post-money valuations will affect the financing, and this is why you need to know what they mean.
What are pre-money valuation and 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.
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 to the pre-money valuation, the post-money valuation always stays on the upper side. The difference between the pre and post-money valuation 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. The only difference between pre-money valuation and post-money valuation is the time of the valuation.
Why is pre-money and post-money valuation important?
Calculating the pre-money and post-money 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:
|Pre Valuation of Business||$30 million|
|Issued Shares||3 million|
|Share to be issued||500,000|
The pre-money valuation of a business is $30 million; before investment, the number of issued shares is 3 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.
Pre-money valuations are also as important. The data is used for future investments. 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. It is a flat round if the current pre-money valuation is similar to the last post-money valuation. 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
Calculating pre-money valuation and post-money valuation is not as difficult if you have the required data and knowledge.
Pre-money valuation Calculation: 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. Also, you can further use this pre-money value to determine the price per share.
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 pre-money 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.
|Price per share||$1|
|Number of shares acquired||100,000|
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.
|Pre-money valuation of a company||$7 million|
|Post-money valuation of a company||$10 million|
|Price per share||$6.36|
|Number of shares acquired||471,689|
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.
|Price per share||Investment|
|Total number of shares issued||1,571,698||-||-|
|Investor A||100,000||$1||$1 million|
|Investor B||471,689||$6.36||$3 million|
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 is 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.
Interested to find out more about pre money vs post money valuations?
Many founders ignore the process of valuation and randomly guess the value of the company once they have made up their mind of giving up a defined percentage of the ownership. Founders do so because they decide that they need a specific investment amount and are willing to give up only a particular part of equity. This might be beneficial, and you might get a higher amount for the equity, but it will rarely happen.
The pre-money valuation is negotiable, and you can use this to your advantage. Understanding the way the valuation works can be beneficial to you while negotiating with investors or founders to get a top deal. While performing a startup pre-money and post-money valuation, the use of the right tools will boost the process and assist in making a well-informed decision. With Eqvista tools for valuation and capitalization tables, one can track the progress with generated reports and summaries. Eqvista tools use all supported and beneficial methods to a wide range of businesses and different situations. Use our 409a valuation services to value your company today!