Pre money valuation is the equity value of a company before it receives the cash from a round of financing it is undertaking. Since adding cash to a company’s balance sheet increases its equity value, the post money valuation will be higher because it has received additional cash.
What is a Pre-Money Valuation?
A pre-money valuation is the value of a company before a new outside investment. Pre-money valuations generally form the basis of what a VC’s share in the company is determined to be worth, based on how much they invest.
If I invest $250k in a company that has a pre-money valuation of $1M, it means I own 20% of the company after the investment: $250k / 1.25M = 20%.
Because the pre-money valuation is determined before each round of financing, it will likely change over time. So a company may have a pre-money valuation at seed that’s $3M, but after it’s grown, its Series A pre-money valuation may be $9M.
There’s no hard-and-fast rule around how the pre-money valuation is determined. Often, it’s open to interpretation by both the VC and founder based on the company’s performance, the market they operate in, competitors in the space, and a host of other factors.
Determining the Pre-Money Valuation
- Comparable businesses. You’ll often hear VCs refer to a company as “the next [INSERT NAME OF SUCCESSFUL STARTUP HERE].” This is based on a comparison of the company to other more established companies in the marketplace. They’ll measure the revenue and market value of more mature companies as a gauge of a startup’s potential.
- Founders and team. When it comes to picking winners at early-stage, Paul Graham places a lot of stock in “good” founders. He defines good founders as people who “make things happen the way they want…have a healthy respect for reality…and are relentlessly resourceful.” Founders who have a successful track record of launching new companies and have assembled a team of smart people around them appeal to VCs.
- Deal interest. If a lot of investors want in on a deal, the founders have leverage and can drive up the valuation of the company—allowing them to retain more ownership. But if a deal is undersubscribed (i.e., low demand), the investors have the power to dictate the valuation of the company.
Pre-Money vs. Post-Money Valuation
When it comes to evaluating early-stage companies, the Pre-Money Valuation refers to how much a company’s equity is worth prior to raising capital in an upcoming round of financing.
Once the financing round and terms are finalized, the implied value of the company’s equity rises by the amount of funding raised, resulting in the Post-Money Valuation.
Pre-Money and Post-Money Valuation: What is the Difference?
In venture capital (VC), the pre-money valuation and post-money valuation each represent the valuation of a company’s equity, with the difference being the timing of when the equity value is estimated.
The pre-money and post-money valuations each refer to different points in the funding timeline:
- Pre-Money Valuation: The value of a company’s equity before raising a round of financing.
- Post-Money Valuation: The value of a company’s equity once the round of financing has occurred.
As implied by the name, the pre-money valuation does NOT account for any new capital expected to be received from investors based on an agreed-upon term sheet.
If a company decides to raise financing, the total amount of new funding is added to the pre-money valuation to arrive at the post-money valuation
How to Calculate Post-Money Valuation?
The post-money valuation is equal to the amount of financing raised plus the pre-money valuation, as shown below:
But depending on the amount of information readily available on the terms of the funding round, the pre-money and post-money valuation could also be calculated using an alternative approach.
If the pre-money valuation is unknown, but the financing raised and implied equity ownership is announced, the post-money valuation can be calculated using the following formula:
For instance, if a venture capital firm invested $4m with an implied equity ownership stake of 10% after the financing round, the post-money valuation is $40m.
- Post-Money Valuation = $4m Investment Size ÷ 10% Implied Equity Ownership Stake = $4Om
What are the Funding Rounds in Venture Capital (VC)?
- Pre-Seed / Seed Stage: The pre-seed and seed-stage round consists of close friends and family of the entrepreneurs as well as angel investors. More seed-stage VC firms have emerged in recent years, but the area remains niche and is typically for unique situations (e.g. founders with previous exits, preexisting relationships with the firm, former employees of the firm).
- Series A: The Series A round includes early-stage investment firms and represents the first time institutional investors provide financing. Here, the startup’s focus is on optimizing its product offering(s) and business model.
- Series B/C: The Series B and C rounds represent the “expansion” stage and comprise predominantly of early-stage venture capital firms. At this point, the startup has likely gained tangible traction and shown adequate progress towards scalability for success to seem achievable (i.e. proven product/market fit).
- Series D: The Series D round represents the growth equity stage in which new investors provide capital under the impression that the company can have a large exit (e.g. undergo an IPO) in the near term.
FAQs
What is the Difference Between Up Round vs. Down Round Financing?
- Up Round Financing → An “up round” means the valuation of the company raising capital has increased in comparison to the prior valuation received.
- Down Round Financing → A “down round,” in contrast, means the company’s valuation has decreased post-financing in comparison to the preceding round of financing. However, a company can certainly recover from a negative round of financing, despite the increased dilution among shareholders and potential internal conflict after the unsuccessful round of financing.
What is the Difference Between Enterprise Value vs. Equity Value?
A company’s enterprise value (EV) is the value of the entire business without considering its capital structure. It’s important to point out that a company’s enterprise value is unaffected by a round of funding. While a company’s equity value increases by the amount of cash, its EV remains constant.
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