The world of startups is a volatile one. When you’re trying to create and grow your own company, it can be stressful to keep up with the latest trends in business. One thing that many entrepreneurs find themselves dealing with is the difference between pre-money and post-money valuations.
Any early-stage startup founder needs to know what these terms mean as they prepare their company for future growth or an IPO – after all, understanding this distinction could make or break your business model.
We’ll look at what each term means, how they differ from one another, how to calculate them, and when it’s appropriate to use them concerning your company. By the time you finish reading this article, you should better understand why/which valuation is right for your business.
What is a pre-money valuation?
Pre-money valuation refers to the value of a company before it raises money from investors. This is usually done in early-stage companies seeking seed funding or venture capital. The pre-money valuation is essential because it sets the stage for ownership percentages and how much equity the founders will give up in return for investment.
For example, let’s say you have a company valued at $5 million pre-money. You’re seeking $1 million in investment from a venture capital firm. In this case, the VC firm would own 20% of your company post-money ($1 million divided by $5 million).
It’s important to note that the pre-money valuation is not set in stone – it’s simply a number that you and your team come up with to give potential investors an idea of how much your company is worth. This number can be negotiated up or down, depending on the circumstances.
Calculating pre-money valuation
When calculating the pre-money valuation, you can use the equation below:
Pre-money valuation = post-money valuation – investment amount
If you have a post-money valuation of 40 million and an investor is giving you 4 million in funding, your pre-money valuation is 36 million.
This method can be helpful if you already have a post-money valuation from investors, but you’re unsure what your pre-money valuation should be.
After calculating pre-money valuation, you can then consider the per-share value. To do this, you should consider these factors:
- The number of shares that have been issued
- The price per share
Per-share value = Pre-money valuation ÷ total number of outstanding shares
For example, let’s say your company has 1,000 shares, and each share is worth $10. That would give your company a pre-money valuation of $10,000.
Why is a pre-money valuation vital to me as a new business owner?
Pre-money valuation is vital to new business owners for a few reasons.
Firstly, it sets the stage for your company’s worth before bringing in any new investors. Investors will use this number to determine how much equity will be given up bringing them on board.
Secondly, it can help you raise funds more effectively. The more your pre-money valuation equals, the more an investor wants to get involved. You can set a higher fundraising goal and give up less equity if you know how much your company is worth.
Finally, it shows potential investors that you have a good handle on your company’s finances and are serious about growing your business.
What is a good pre-money valuation for a startup?
A reasonable pre-money valuation for a startup will depend on a few factors, including the stage of the company, the industry, and the amount of money being raised.
For example, early-stage startups typically have a lower pre-money valuation than later-stage companies because they are riskier and have less revenue potential.
The industry also plays a role in the pre-money valuation. In sectors with high potential growth, such as technology or healthcare, startups tend to have higher valuations than slower-growing industries.
Finally, the amount of money being raised also affects pre-money valuation. If a startup is looking to raise a lot of money, it will likely have to give up more equity. Their pre-money valuation will be lower as a result.
What is a post-money valuation?
A post-money valuation can best be defined as the value of a company after new investors are brought in. Post-money valuations are essential as they show how much value has been created by the new investors. The valuation of a company can increase or decrease after a new round of funding, and the post-money valuation will reflect this change.
Calculating post-money valuation
The post-money valuation can be calculated using the following formula:
Post-money valuation = Investment dollar amount ÷ percent investor receives.
For example, if an investment is worth $5 million and nets an investor 10%, the post-money valuation would be $50 million:
$5 million ÷ 10% = $50 million
Do post-money valuations matter?
Post money valuations matter because they directly impact the number of equity investors receives in return for their investment.
A startup is looking to raise $1 million at a pre-money valuation of $5 million. This gives the company a post-money valuation of $6 million.
If an investor puts in $1 million, they will own 16.7% of the company.
However, if the startup raises the same amount of money but at a post-money valuation of $10 million, the investor will only own 10% of the company.
While post-money valuations may not be as crucial as pre-money valuations, they still play a significant role in fundraising.
So, what is a good post-money valuation for a startup?
Similarly to pre-money startups, a good post-money valuation is based on a few factors, such as the stage of the company, the industry, and the amount of money being raised.
For example, a startup that has recently completed its Series A investment round of funding will likely have a higher post-money valuation than one in the early stages of development.
The same is true for startups operating in different industries; a biotech startup will likely have a higher post-money valuation than a consumer goods startup.
The startup’s amount of money will also impact its post-money valuation. Typically, the more money a startup is looking to raise, the higher its post-money valuation will be.
You’ll want to aim for a post-money valuation around 3-5x your current pre-money valuation. This will give your startup a healthy runway and room to grow.
Of course, it’s helpful to keep in mind that a post-money valuation is not a set number – it can and should be negotiated up or down depending on the circumstances. You can ask for a higher post-money valuation if you have an attractive product or service with a large addressable market. Similarly, if you’re targeting a small market or have much competition, you may need to accept a lower post-money valuation.
The most important thing is to ensure that your startup is adequately valued, whether pre-money or post-money. Undervaluing your startup will leave you with too little capital to grow and scale while overvaluing it will make it difficult to attract investors.
If you’re not sure what a fair post-money valuation would be for your startup, the best thing to do is talk to an experienced startup lawyer or advisor. They’ll be able to help you navigate the complex world of startup valuations and ensure that you end up with a fair deal.
Visit the link for resources relating specifically to early-stage startups and guidance on valuations. Early-Stage Startup Program
What is the difference between pre-money and post-money valuations?
The main difference between pre-and post-money valuations is that the former only considers existing shareholders, while the latter includes current and future equity holders. This is an important distinction because it can impact how much money a company raises.
For example, suppose you’re trying to raise $1 million in a Series A funding round, and your pre-money valuation is $5 million. In that case, you’ll need to find investors who are willing to contribute at least $6 million (the $1 million you’re looking for plus 20% of the $5 million).
However, if your post-money valuation is $6 million, you’ll only need to raise $1 million from investors.
Why do valuations matter?
Valuations matter to new and existing businesses for a few reasons:
They provide a way to establish how much a company is worth. This number can be helpful for various purposes, such as setting a price for selling the business, determining how much equity to give employees, or raising money from investors.
Valuations can also help businesses benchmark their progress and performance. By tracking changes in valuation over time, startups can see whether they are gaining or losing value.
Finally, valuations provide a yardstick against which businesses can measure themselves against their peers. This is particularly important for early-stage startups that may not have financial data to compare themselves with other companies in their industry.
“Up Round” vs. “Down Round” Financing
“What are the financial implications of raising capital at different points in a startup’s lifecycle?” This is one of the critical questions that early-stage startups need to answer as they consider their fundraising options.
There are two primary categories of financing rounds: up rounds and down rounds.
An up round is when a startup raises more money than it has previously raised, while a down round is when a startup raises less money than it has previously raised.
The terms “up round” and “down round” can be confusing as they don’t necessarily reflect the overall health of a company. A company that is performing poorly could still raise an “up round” if it increases the valuation of its shares. Conversely, a company that is doing well could still raise a “down round” if it lowers the price of its shares.
Raising capital at different points in a startup’s lifecycle can have significant financial implications. An up round is when a startup raises more money than it has previously raised, while a down round is when a startup raises less money than it has previously.
Understanding the concept of pre-money and post-money valuation as detailed above is also helpful in seeing the financial implications of up and down rounds. It also helps to make sound decisions about your fundraising options. A properly conducted valuation can help your business grow by clearly understanding what your business is worth in the current market.
