Pre-Money and Post- Money Valuation

The field of venture capital is replete with terminology that is detail orientated, and specific to individual business situations. Any venture capitalist worth their salt understands the basic differences between, a Bear and a Bull market.  However, other more arcane verbiage must also be contended with to ensure that all parties in a deal are not only on the same page, but are also working from the same book. Pre-money and post-money valuation represent two such deal terms that must be understood prior to writing, or accepting, any cheque for investment purposes.

Understanding Pre-Money and Post-Money Valuation

Those remotely familiar with real estate are aware of the adage, “Location, location, location” when it comes to determining the ultimate value of a piece of property. For the venture capitalist, a proper understanding of the difference between pre-money and post-money valuation is based upon, “Timing, timing, timing.”

Simply stated, pre-money is the valuation of a company prior to any outside investment force, whereas post-money valuation looks at the equation after the firm has received an injection of outside capital. Is this a case of tomato vs. tomato? Not at all.  The two terms have two distinctly different meanings that have have a huge impact on the bottom line of both the entrepreneur’s and investor’s ownership stake.

Simple Valuation Math

Imagine that an investor has some venture capital to invest in a business, and is looking to determine what type of ownership stake that their investment will buy. As such, an investor and the entrepreneur in a new start up determines that the actual value of the company is $100,000, and the investor is willing to invest $25,000 in the company. Whether the investor’s $25,000 investment is pre-money or post-money, the resultant ownership stake can vary widely.

If the total valuation of $100,000 represents pre-money, the addition of $25,000 would boost the company’s valuation to $125,000. Of that, 80% of that valuation would represent the entrepreneur’s ownership stake, while the venture capitalist would hold one fifth, or 20%.

Conversely, if the company’s valuation is $100,000 after the injection of outside financing, otherwise known as post-money, then one would see a larger ownership stake (percentage) for the investor. In this case, the venture capitalist’s $25,000 would result in a 25% ownership stake while the entrepreneur would retain three-quarters, or 75% of the valuation ownership.

Does 5% matter?  Absolutely.  It may not seem like much at first, but depending on the share rights attached, it can make a huge difference.  We’ll get to the rights in future parts of this series, but of key immediate interest should be participation rights, and preferences.

July 26, 2016

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