In the world of venture capital and startups, understanding a company’s valuation is constantly on your mind, and there are a few details that are important in that conversations. Any company looking to accept funding will have a pre-money valuation and a post-money valuation, and it’s vital to understand the difference and what it means for investors.
The main difference between pre-money and post-money lies in the timing of the valuation. Since the timing is so important, it’s vital to make sure you know which type of valuation you’re talking about. They are both valuation measures for companies and essential to determine how much a company is worth and how ownership shares shake out down the road.
Pre-Money Valuation Basics:
Pre-money valuation is focused on the value of a company not including any latest rounds of funding or external funding. It focuses on the worth of the startup prior to receiving any investments. It allows investors to get an idea of the current value of the business, as well as the value of shares issued. Pre-money valuations often can vary due to many factors in timing, debt-to-equity conversions, pro-rata participation rights, and market opportunity seen by stakeholders/founders.
Examples:
- Suppose a startup has a pre-money valuation of $1 million, and the founders own 100% of the company. If they receive $500,000 in funding, the post-money valuation would be $1.5 million, and the founders would own 66.7% of the company (since they gave up 33.3% of the equity in exchange for the investment).
- Imagine a startup has a pre-money valuation of $10 million, and the founders own 80% of the company. If they receive $2 million in funding, the post-money valuation would be $12 million, and the founders would own 67% of the company (since they gave up 13% of the equity in exchange for the investment).
Post-Money Valuation Basics
Post-Money valuation, though, focuses on how much a company is worth after any investments have been made. It includes outside financing or recent capital investments. Although post-money valuations are a little simpler and straightforward, pre-money valuation is more commonly used in investment conversations.
Examples:
- Imagine a startup has a post-money valuation of $5 million after receiving a $1 million investment. If the founders owned 100% of the company before the investment, they would now own 80% of the company (since they gave up 20% of the equity in exchange for the investment).
- Consider a startup that has a post-money valuation of $20 million after receiving a $5 million investment. If the founders owned 75% of the company before the investment, they would now own 60% of the company (since they gave up 15% of the equity in exchange for the investment).
Why should you care about pre-money vs. post-money?
The main why behind the conversations of pre vs. post comes down to timing. The main reason you’d care about what type of valuation you’re referring to is when it comes to ownership percentages, and not so much at first, but if a company goes public the ownership percentage can be drastically different based on what valuation you’ve considered. When you’re initially considering an investment in a company, knowing which valuation you’re basing investment negotiations upon matters a lot. It’s a small detail that could make a BIG difference down the road.
The other main difference between pre-money and post-money valuation is found in the insights they give investors. A pre-money valuation will give value into the potential shares issued while post-money valuation provides a clear numeric value equating to the current value of the difference. These valuations also have a large impact on determining the percentage of a company a potential investor is going to acquire for their investment, while also showing the percentage of the company any existing stockholders will retain.
Understanding the pre-money and post-money valuations can help an investor make smart decisions about investment decisions, especially as the company grows down the road. Every startup founding team wants to make sure they are setting themselves up for a profitable end game.
At Sentiero, we’re constantly assessing companies based on pre-money and post-money valuations to better understand the opportunity and risks for any potential investment. And it’s vital that any funding teams understand these nuances as well. These are regular topics in the valuation conversation that should be understood by all both for the initial investment, but the impact for everyone in the long run.