Pre-Money vs. Post-Money Valuations…What Your Startup Needs to Know

October 15, 2019

Many startup owners struggle with the concepts of pre-money and post-money valuations when seeking outside equity investments. In short, pre-money valuations refer to the valuation of the company before the…

Many startup owners struggle with the concepts of pre-money and post-money valuations when seeking outside equity investments. In short, pre-money valuations refer to the valuation of the company before the investment has been made, while post-money valuations refer to the value after the investment has been made.

However, calculating these values can often be complex, and small differences can be sticking points between the company’s founder(s) and any outside investors – and yet the valuations can often have a tremendous impact on the success or failure of any financing round. Since invested capital is often crucial to startups, this can mean the difference between success and failure of the startup.

The Impact of Valuations

It’s crucial to understand that the complexity of both pre-money and post-money valuations lies not only in the formula for each, but also because valuation negotiations are often speculative. Ultimately, the value will be driven by market forces (which are unknown at the time investment is sought). This scenario can frequently lead to very different estimates of valuation by the founders and the investors.

Existing owners or shareholders will often seek a higher valuation so that ownership of the company isn’t as diluted after the investment round. Investors will seek a low valuation so that they can maximize their stake in the company that is granted after the investment. This situation can lead to conflicting estimates.

It’s All About the Timing

While both pre- and post-money valuations are measures of the company’s worth, the difference between the two lies in timing – either before or after the equity investment has been made. Pre-money valuations are more commonly used, yet post-money valuations are easier to calculate.

Pre-money valuations are often complicated by the fact that the value of the business relies on many variables that are unsettled before the investment has been made, such as the inclusion of debt-to-equity conversions and pro-rata participation rights, among others. The face value of these elements is already included in the post-money valuation at the time that an investment is made.

The amount of impact that this difference in valuation can have is huge. The difference may be best illustrated by looking at a company valued at $1 million – both during pre- and post-money investments. If an investment of $500,000 is made to a company with a pre-money valuation of $1,000,000, the investor would receive 33% ownership. If the same investment is made post-money, the investor receives 50% ownership – clearly, this has a huge impact on the ownership structure, which is why both parties are heavily interested in what type of valuation is used.

Why Is This Important to Me?

It’s clear that the method of valuation impacts the relationship between the amount of investment and ownership of the company. As a startup owner, you will want to thoroughly understand both numbers, as well as any future implications that may be related to the current method of valuation. Because of the complexity in these instances, it is always good to have an attorney to consult who understands all of your options and can help you find the best path forward while your company grows.

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