How do pre-money and post-money valuations work?
31st August 2022
Understanding the difference between pre-money and post-money valuations is essential for setting up your startup company. In addition, knowing these values will help you decide if it’s the right time to take on funding and look for angel investors or venture capital backing, and better explain your idea, values, and plans.
Pre-money and post-money valuations both represent a company’s equity, but the difference is in the timing. You can also expect the values of your pre and post-valuations to shift a little, too; for example, it’s normal to have a pre-money valuation when you are just getting started and another before a Series A round.
Something you should keep in mind is that these numbers can provide very different insights to your potential investors and are equally critical to your company’s funding success. They are also a great tool to help you negotiate the best funding options for your startup.
What is a pre-money valuation?
A pre-money valuation is what your company is worth before receiving any external funding or having gone through any financing rounds.
You can usually determine this value yourself if you are a founder or an existing stakeholder, but it is better defined as the amount that an investor and the startup will agree the company is worth. The number is not so much derived from accounting measures but from the negotiations between the interested parties.
One of the main reasons you need to know your pre-money valuation early is that it provides investors with a potential value for your share price. A reasonable pre-money valuation can help you prepare for and retain a solid post-money evaluation.
What is a post-money valuation?
Unlike pre-money values, a post-money evaluation measures what your startup is worth after a round of funding has already happened. In other words, the amount that a pre-money valuation will be worth immediately following an investment.
The post-money valuation includes the pre-money valuation plus the amount of financing you have raised. For example, if your pre-money valuation was $2m and you received a $8m new money investment, your post-money value is $10m.
Some common examples of venture funding rounds that will eventually help you determine the post-money value include:
- Pre-seed and seed funding round: Family members, close friends, and acquaintances act as angel investors, financing your business idea, usually in exchange for a minority stake.
- Series A funding round: This is usually the most important type of early-stage investment. It typically includes firms interested in optimizing a product and able to provide a runway for startups to develop their offering. These investments usually take the business to the next level and past the stage of development.
- Series B/C funding round: An expansion stage (or stages) where venture capital firms help with financing to scale the company. The goal is to make the startup appealing for acquisition or public offering.
- Series D funding round: New investors can provide capital, having seen the company grow. A series D sometimes occurs when the business couldn’t meet the targets of its Series C and might be at a lower valuation.
Calculating Your Pre-Money Valuation
The most popular formula you can use to calculate your pre-money valuation requires you to know your post-money value. It is as follows:
Pre-money valuation = Post-money valuation – Investment amount.
You will need to know where you want your company to go and then subtract the amount required for the investments that will get you there. Your projected goal should always include the factors that make your company attractive to investors.
For example, if your post-money valuation was £10m and your investment was $4m, your pre-money valuation will be a total of $6m.
Once you have the pre-money valuation, you can also calculate the per-share value using the following formula:
Per-share value = Pre-money valuation / total number of outstanding shares.
Calculating Your Post-Money Valuation
You can use a straightforward formula to calculate the post-money valuation, so we will cover it before moving on to the pre-money valuation.
When you don’t know the pre-money valuation value of your company, the way you can calculate the post-money valuation is:
Post-money valuation = Financing raised / Percentage of equity ownership
There is also an alternative approach to the formula when you have the pre-money amount (which we will see in the next section):
Post-money valuation = Pre-money valuation + Financing raised to date.
Alternatively, you can use:
Post-money valuation = Financing raised / Percentage of equity ownership
For example, if your company received an investment amount of $5m and an implied equity stake of 10%, your post-money valuation will be $50m.
The difference between “Up round” and “Down round”
You will be able to determine if you had an up round or down round only once you have calculated the difference between the starting evaluation and the ending one (after a round of financing).
If the valuation of a company that is raising capital has increased when compared to the prior valuation it had received, it is up-round financing. If it has decreased post-financing, it is down-round financing.
A down-round financing result is not uncommon. Despite stakeholder dilution, startups can recover from negative financing rounds. For example, if they can show the funding was a lifeline required to stay afloat and eliminate the risk of bankruptcy.
Why startup valuation is usually fluid
Pre-money valuation and post-money valuation tend to be flexible, typically speculative and driven by the market, stakeholders, entrepreneurs, and investors.
For example, the owner of a startup will usually go for a higher value, as they believe in their idea and can see its full potential better than anyone else. New investors, on the other hand, will focus more on risk and ensure they are not overpaying. Their valuation might be lower.
Post-money values tend to be easier to calculate – because it’s done looking back. Pre-money valuations, although much more common for new startups, have to keep several factors in mind. Some things that can affect a pre-money valuation include:
- Employee share plans (plans you can give to your employees, so they become shareholders)
- Pro-rata participation rights (previously agreed-on rights given to previous investors, typically involving ownership rights)
- Debt-to-equity conversion (any situation with the potential to take debt and pay it back accompanied by a specific amount of stock)
- Market forces and novel opportunities.
How pre-money valuation affects post-money valuation
One crucial consideration to keep in mind is that your company’s pre-money valuation will affect the post-money valuation as well. For example, if a company finds a suitable gap in the market and grows quickly, it can generate investor interest and get an excellent pre-money value. The greater this pre-money evaluation is, the more an investor will be willing to pay for a share of your company.
Price per share (or PPS, “share price“) is the market price per share of stock and is established based on what a buyer is willing to pay for a stock and the price a seller wants to accept for it. Getting good funding can help you achieve a solid PPS and prepare for an eventual successful acquisition.
However, calculating your PPS when you are a new company is not always easy. You will first need to know your pre-money valuation and then divide this number by the fully diluted capitalization. If the PPS goes up, the pre-money valuation will go down proportionately (and the same should happen in the other direction).
To prepare for an IPO or acquisition, you should always make sure you time your funding with the best pre-money valuation and post-money valuations you can achieve.
Why is pre-money and post-money valuation important?
There are several reasons why pre-money and post-money valuation matter. For instance, these values can be a great tool to discuss your startup and show you have a solid plan.
It’s common for founders and investors to engage in negotiations over what pre-money valuation is for a particular company. These disagreements are not always easy to resolve, especially in the early stages – when the value of a company is still not entirely clear. However, coming up with approximation numbers can be extremely valuable.
Because the value of a company can be up for intense debate (and founders will always tend to be more optimistic), venture capital firms will typically try to “bridge the valuation gap” by, for example:
- Setting up a liquidity preference (so, if the company is sold, they get paid first)
- Getting more participation rights (and additional upside)
- Choosing a preferred rate of return on their investment.
- Asking for anti-dilution rights (so they can be protected against potential future dilutions)
Helping investors make a decision
One of the benefits of having solid pre and post-money valuations for your startup is that these values can help potential investors determine what percentage of your company they will acquire and retain. Some investors also prefer to use special assurances or warranties; for example, convertible notes delay evaluation until a later date (when the product gap is more apparent and the company is more mature).
Helping you explain your value
Another reason these values are so important is because they can help you negotiate funding for your startup. Pre-money and post-money valuations are a great way of explaining the mechanics of your business and showing you understand (and can communicate) your potential.
Giving your employees more information
Knowing your pre-money and post-money valuation numbers is also a great way to help your employees understand their stock options, attract new talent, and prepare your own plans for after acquisition.
Pre and post-money valuations – Frequently asked questions
Is a pre-money valuation more important than a post-money valuation?
No; both values are essential for startups and work together to determine your company’s value once the financing round is done. The pre-money valuation can, in fact, affect the post-money valuation. Both these values can also be used as shortcuts to calculate each other more easily – so they are equally essential for your business.
Do pre-money valuations impact financing?
Your determined pre-money value has a large impact on what size of ownership stake an investor might consider. This is because the PPS (price per share) that an investor is willing to pay is directly proportional to the pre-money value you have agreed on (if one goes up, the other goes down). Keep in mind that this value refers to the equity value of the business – not the share price.
If you’re looking to explore funding options, need working capital in between your funding rounds, or need some help determining the best financing option for your startup, don’t hesitate to get in touch.