Pre-money and post-money are measures of valuing a company. Pre-money valuation refers to the company’s value before the investor makes an investment in the company and post-money valuation refers to the value of the company after the fund is infused into the company. Let’s take an example to understand the concept.
Let’s assume that an Investor agrees to invest $300,000 in a start-up which is valued at $1 million. The following table explains how the ownership changes in both the situation for the same amount of investment. Let’s ignore the option pool for now to keep it simple.
|
Individual |
Pre-Money Valuation | Post-Money Valuation | ||
|
Value |
Ownership | Value |
Ownership |
|
|
Entrepreneur |
1,000,000 |
77% | 700,000 |
70% |
|
Investor |
300,000 |
23% | 300,000 |
30% |
|
Total |
1,300,000 |
100% | 1,000,000 | 100% |
As we can see above, the ownership percentage depends on the value placed on the company – pre-money or post-money. In pre-money valuation, the company is valued at $1 million before the investment. So, after the investor’s funding, the total value of the company increases, thereby decreasing the investor’s share of ownership. In post-money valuation, the company is valued at $1 million after the investment. So, the investor share increases by 7%. This percentage difference looks small, but can reflect millions when the company goes public.
Investors like Venture Capitalists and Angel Investors generally use the pre-money valuation to determine the “ask” – percentage ownership in the company against the funding – and is calculated on a fully diluted basis. Usually, a fund raising company receives a series of funds (Series A, Series B, Series C, etc.) so that investors minimize the risk of their investment. It’s also a way to motivate the Entrepreneur to achieve the agreed upon milestones. The pre-money and post-money concepts apply to each subsequent series of funding.
Determining pre-money and post-money valuation through formula
Post-money valuation = New funding x (post investment shares outstanding /
shares issued for new investment)
Pre-money valuation = Post-money valuation – new funding
For example, Company A owns 100% stake with 1,000 shares. Investor A infuses $1 million capital into the company against 200 shares (20% ownership), the post-money valuation will be:
$1,000,000 x (1,200/200) = $6 million
Pre-money valuation = $6 million – $1 million = $5 million
The same approach to calculation applies to subsequent series of funding as well.
You may also refer my article on Valuation: Asset Approach, Income Approach and Market Approach here.
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