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A Guide to Help You Understand Pre- vs. Post-Money Valuation
Pre vs post-money valuation is among the most integral terms in the startup vocabulary. These are used extensively during the venture capital financing round and are key to the success (and failure) of a startup. So what are pre-money and post-money valuations exactly and what makes them important? This guide will give you a complete overview of this subject as well as discuss pre vs post-money valuation, their pros and cons, and how you can calculate them.
What is a Pre-Money Valuation?
A pre-money valuation is a company’s estimated value before receiving new capital from investors. This valuation provides investors with a basis for determining the equity ownership or stake of existing shareholders and the value of each share to be sold to new investors.
- Provides a perception of the future value of the company to help entrepreneurs seek funding accordingly
- Determines the equity ownership of investors and affirms the decision-making power of the company
- Promotes transparency in negotiation by ensuring that the investment price fairly reflects the company’s value
- Provides a framework for determining the terms of the investment and can be used as a benchmark for negotiations
- May not accurately reflect the company’s future potential, which can lead to potential disagreement between investors and the company
- Can be influenced by personal biases, leading to overvaluation or undervaluation of the company
- Might limit the flexibility of the company and its investors, as it sets expectations for the company’s future growth and success
Pre-Money Valuation Example
Let’s say a startup company has a pre-money valuation of $7,000,000. This means that the company’s current value, without any new investment, is $7,000,000. A potential investor offers to invest $3,000,000 million in exchange for a 20% stake in the company. The pre-money valuation would not change. It stays at $7,000,000.
What is Post-Money Valuation?
The post-money valuation is the value of a company after new capital has been added through investment. It is calculated by adding the amount of new investment to the company’s pre-money valuation. It is used to determine the equity ownership of existing shareholders and new investors and set the price per share to be sold to new investors.
- Provides an accurate representation of the company’s current value and future potential
- Shows investors how much the investment will be worth after post-investment
- Helps companies negotiate better terms and higher capital with the investors
- Helps determine the equity ownership of existing shareholders and new investors, establishing the decision-making of the company
- Impacts the company’s ability to scale
- Affects the amount of equity received by investors
- High post-money valuation of the company can lead to future problems, such as layoffs, salary cuts, or unhappy customers
- A low post-money valuation can lead to difficulty in raising capital and selling equity
Post-Money Valuation Example
Let’s take a look at the same example (pre-money valuation) for post-money valuation. The startup company has a pre-money valuation of $7,000,000, and the potential investor offered to invest $3,000,000 in exchange for a 20% stake in the company. After the investment, the post-money valuation of the company would be $10,000,000, which is the total valuation of the company post-investment.
A Simple Example of Pre-Money vs Post-Money Valuation
The reason why the pre vs post-money valuation understanding matters is that it can significantly affect ownership shares. For instance: A company has a pre-money valuation of $10,000,000. A new investor offers to invest $2,000,000 in exchange for a 20% stake in the company. This means the investment will buy the investor a 20% stake in the company, which amounts to a post-money valuation of $12,000,000.
$10,000,000 (pre-money valuation) + $2,000,000 (investment) = $12,000,000 (post-money valuation)
The new investor would own 20% of the company, or $2,400,000 ($12,000,000 x 20% = $2,400,000)
The existing shareholders would own the remaining 80% of the company, or $9,600,000 million ($12,000,0000 ˗ $2,400,000 = $9,600,000).
If the investor had agreed to the same investment for a post-money valuation of $10,000,000, their investment of $2,000,000 would buy them a different stake in the company. Let’s understand why:
Post-money valuation – the size of the investment = Pre-money valuation
$10,000,000 – $2,000,000 = $8,000,000
Now the investor will get a $2,000,000 or 25% stake in the company for the pre-money valuation of $8,000,000.
This means when the investor agreed to the pre-money valuation of $10,000,000, the investor received a 20% stake in the company. However, when the investor agreed to the post-money valuation of $10,000,000, they were getting a 25% stake in the company. The pre vs post-money valuation can make a drastic difference in the ownership of the company.
Calculating Pre-Money Valuation
The pre-money valuation of a company is entirely subjective and is done before the funding is received; however, if you know the post-money valuation of the company, the pre-money valuation can be calculated using the following formula:
|Pre-money valuation = Post-Money Valuation – Investment Amount|
Furthermore, the calculation for pre-money valuation determines the share value:
|Per-Share Value = Pre-Money Valuation / Total Number of Outstanding Shares|
Calculating Post-Money Valuation
The calculation for post-money valuation is as follows:
|Post-Money Valuation = Pre-Money Valuation + Size of Investment|
Another way to calculate post-money valuation is through the share price. The share price is simply the investment received divided by the number of shares that the investor buys the investor:
|Share Price = New Investment Amount / Number of New Shares Received|
Now you know that the share price of the post-money valuation of the company can be calculated using the following formula:
|Post-money valuation = (New Investment amount / Number of New Shares Received) x Total Number of Shares Post-Investment|
ALSO READ: What is Profitability Analysis? How Does it Help Businesses Grow?
Learn Valuation with Emeritus
Pre- vs post-money valuation sets the expectations for the future growth and success of a company. However, be sure to reduce biases from these values as undervaluation or overvaluation will have a significant impact on the future of your venture. Remember, when you step out to represent your company to investors, a detailed pre- vs post-money valuation report plays an influential role. But it is not the only factor an investor will consider; make sure you have a detailed financial and business plan prepared too. If you are looking to grow your business, it is important to keep learning and developing your knowledge in these areas. To do that, explore these entrepreneurship courses offered by Emeritus, taught by experts from the world’s best universities.
By Krati Joshi
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