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Pre-Money and Post-Money Valuations: the Differences
Pre-money and post-money valuations are critical when negotiating with potential investors — but what do these terms mean, and how are they calculated?
A startup founder launching a new funding round is inevitably exposed to a wide, new vocabulary. The world of fundraising is home to many terms that new startup founders must rapidly become familiar with. Some of the most important terms a startup founder must understand are “pre-money” and “post money” — but what do they mean?
Both pre-money and post-money are terms that are often used during VC investment rounds, appearing during negotiations between startups and investors, or within your term sheet or cap table. Pre-money and post-money valuations are critical to the bottom line of your business as a startup founder, so it’s important to understand what they represent and how they impact the finances of your startup.
Valuation is a highly important issue and is typically discussed with your investors. Discussions focused on valuation are speculative, and often contradictory — startup entrepreneurs and investors typically possess different estimates of valuation.
Both pre-money valuation and post-money valuation are measures of the value of a company, but differ in timing. Pre-money valuations reference the value of a startup or company before an investment round, whereas post-money valuations reference the value of a business after a successful investment round.
Understanding how these valuations work and how they are calculated, however, can be somewhat complex. Here’s how pre-money valuation and post-money valuation works:
Pre-money valuation refers to the value of a company excluding any funding rounds or external funding. Put simply, pre-money valuations refer to how much a startup or company is worth before it receives any capital from investors at any stage.
Pre-money valuations don’t provide potential investors with any insight into the current value of a business, but they can deliver insight into the potential value of each issued share.
Post-money valuations, when compared to pre-money valuations, are more complicated. A post-money valuation refers to the total worth of a company subsequent to any capital provided by external sources, investors, or funding rounds.
It’s important to note that pre-money valuation includes external financing or any recent capital injection into a company, as these factors are essential to the valuation process.
The difference between pre-money valuation and post-money valuation is best explained with an example.
Let’s say, for example, that an investor is interested in investing in a promising tech startup. The startup entrepreneur and the investor concur that the startup possesses a value of $1 million. The investor, in this case, will contribute $250,000.
The equity distribution or ownership percentages in this situation are dependent on whether the $1 million valuation of the startup in question is a pre-money valuation or a post-money valuation.
If the $1 million valuation is a pre-money valuation, the startup is therefore valued at $1 million prior to investment, and will thus be valued at $1.25 million after the addition of a $250,000 investment from the investor.
If the $1 million valuation is a post-money valuation, however, it takes into account the investor’s addition to the startup, placing the pre-money valuation of the startup in this case at $750,000.
The difference between these two scenarios has a significant impact on ownership percentages. In the first scenario, the investor is contributing one fifth of the post-money valuation of $1.25 million, equivalent to a 20 percent ownership share.
In the second scenario, the investor is contributing one quarter of the post-money valuation of $1 million, equivalent to a 25 percent ownership share. While 5 percent may sound like a small difference, such an amount could potentially represent millions of dollars should the startup go public.
In both cases, determining the correct value of the startup in question is a largely subjective matter, creating a difference of opinion that is resolved through negotiation between the investor and the startup entrepreneur.
How to Calculate Post-Money Valuation
Calculating a post-money valuation of a company is not a complex process. The post-money valuation of a company is calculated as the investment amount divided by the percent the investor receives.
An investment of $3 million that provides an investor with 10 percent, for example, would dictate that the post-money valuation of the company invested in is $30 million.
It’s important to note, however, that this valuation does not dictate that the company is valued at $30 million prior to the $3 million investment.
How to Calculate Pre-Money Valuation
Pre-money valuation provides potential investors with insight into the current value of a company. Calculating pre-money valuation is not a complex process, but requires an additional step that is performed after calculating a post-money valuation of a company.
The pre-money valuation of a business is calculated as the investment total subtracted from the post-money valuation.
Using the same example expressed in post-money calculation, the above formulate dictates that the pre-money valuation of the company is $27 million. In this case, we reach this valuation because we subtract the investment total from the post-money valuation.