First off, be sure to consult legal counsel before signing any documents and do your own due diligence.
When it comes to raising capital for your startup, two terms that often come up are post-money valuation and pre-money valuation. These terms can be confusing if you're not familiar with the world of finance and investment, but understanding them is crucial when negotiating investment deals. So, what exactly is the difference between post-money valuation and pre-money valuation?
Pre-Money Valuation:
Pre-money valuation refers to the value of a company before any external funding or investment has been raised. It’s the value of the company BEFORE any money comes in. It represents the overall worth of the company on its own merit without factoring in any additional cash injections. Pre-money valuation is calculated based on various factors such as revenue, assets, market potential, intellectual property, management team experience, and growth projections.
Post-Money Valuation:
Post-money valuation refers to the value of a company after external capital injection or investment has been received. In simple terms, it takes into account not only the existing value of the business but also considers new investments made by venture capitalists or angel investors. It’s the value of the company AFTER any money comes in. Let’s talk about the differences in these valuation and how it affects ownership:
Let’s say your investor is investing $1 million dollars into your company. They are looking at $4 million as the valuation.
How does ownership change depend on whether the valuation is pre-money? The company is valued at $4MM BEFORE the money comes in, so it is calculated as $1MM/$4MM = 25%.
How does ownership change if the valuation is post-money? It is calculated as $1MM/$5MM = 20%.
Why Does It Matter?
The distinction between pre-money valuation and post-money valuation is important for several reasons: 1. Dilution: Understanding these terms will help you determine the extent to which your ownership in the company may be diluted by future investments. If an investor is contributing a significant amount of money, it can potentially reduce your ownership percentage in the company.
The example above involves only one investor. Imagine multiple investors and each have their own post-money valuation. This can dilute your ownership quite significantly. 2. Negotiating Power: The difference between pre-money and post-money valuations can affect negotiations with investors. A higher pre-money valuation gives you more leverage since it implies a greater perceived value of your business before new investment comes into play. Investors may prefer to use post-money valuation because it provides a clearer idea of what ownership may look like after a priced round. There are still ambiguities but investors often prefer post-money valuations. 3. Decision-making: Knowing these figures will allow you to make more informed decisions about how much equity you are willing to give up in exchange for funding. It gives you another lever to play with when negotiating a deal. Often it might work to your favor by starting the conversation with the valuation cap and whether you want the valuation to be pre or post money and then go into the percentages. At the end of the day, you should construct your cap table based on what you think your company will need down the line, what each investor brings to the table, and definitely seek legal counsel before actioning any agreements.
Credit
Brian Leung is a seasoned marketer with 15 years of experience in digital marketing and 10 of which was focused in Google Ads and PPC. He’s worked with close to a dozen Fortune 500 companies and several well-known startups and ecommerce brands. He owns an agency called Treebud and an AdTech startup called SwiftAds.
He’s on a mission to help 1,000 small business owners 10x their business within a year. The legacy he wants to leave for his son is one of kindness and willingness to help others.
Company website: https://SwiftAds.io
LinkedIn profile: https://linkedin.com/in/bkhleung
Contact email: bleung@swiftads.io
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