Pre-Money Vs. Post-Money Valuation

You must have seen many startups make headlines with their pre- and post-money valuations, and maybe now it's your time to raise money and decide these valuations for your company.

But what do they mean?

Before a startup receives funding, it's valued at a certain amount, which is called the pre-money valuation. The post-money valuation is the sum of a startup's value before the funding round plus the raised money.

What is pre-money valuation?

This is your company's value before any new investment comes in. Factors influencing pre-money valuation include:

- Revenue multiple used in your sector: For example, if you run a quick commerce business and most players in your sector have been valued at 2X their revenue, then your valuation could also be around twice your revenue.

- Competition within your industry: In competitive industries such as AI in 2024 and FinTech in 2020, valuations of companies may be determined by investors depending on how lucrative the business opportunity is. This may or may not have anything to do with your revenue.

- Subjective leverage: Sometimes, founders and their founding teams' past entrepreneurial experience and domain knowledge, along with their perceived ability to succeed, enable them to negotiate higher pre-money valuations.

How to calculate pre-money valuation?

In India, companies usually get their valuations done before each funding round via a registered valuer or a merchant banker. In the U.S., this exercise is called a 409A valuation, and it is mandatory for companies to conduct this annually.

Valuators employ various models such as Market Multiples, Discounted Cash Flow (DCF), and Asset-Based Valuation to determine a company's value. These models analyze financial statements, projections, industry benchmarks, trends, and other relevant data points.

However, if you know the post-money valuation of the company and the amount raised through investment, you can calculate the pre-money valuation using the formula:

Pre-money Valuation = Post-money valuation - Investment amount

For example, if a startup has a post-money valuation of $1.5 million after receiving a $500,000 investment, its pre-money valuation would be $1 million.

Pre-money valuation is often used to determine the price per share at which new investors will acquire a stake.

Price per share = Pre-money valuation/ Total number of outstanding shares

What is post-money valuation?

This is your company's value after the investment round is complete. It's calculated by adding the new investment amount to the pre-money valuation. This number reflects the company's value with the fresh influx of capital.

How to calculate post-money valuation?

Post-money valuation = Pre-money valuation + New investment

For example, if a startup has a pre-money valuation of $1 million and receives a $500,000 investment, its post-money valuation would be $1.5 million.

Pre-money valuation Vs Post-money valuation

Pre and post-money valuations both play different roles during a funding round.

Why is pre-money valuation important?

It helps determine the number of new shares the new investor will receive and the price per share at which they are issued.

Consider this:

• Your startup has a pre-money valuation of $1 million.
• You're raising $500,000 in investment.
• Before the investment, your company has 1 million outstanding shares (all owned by the founders).

First calculate the price per share: 

Price per share = Pre-money valuation / Total number of outstanding shares

Price per share = $1 million (pre-money) / 1 million shares = $1 per share

Now, let's calculate how many new shares the investor receives for their $500,000 investment:

Number of new shares = Investment amount / Price per share

Number of new shares = $500,000 / $1 per share = 500,000 shares

Ownership percentage:

Although not the primary focus of pre-money valuation, you can also calculate the new investor's ownership percentage based on the total number of shares issued to them.

By issuing 500,000 new shares, the investor now owns 500,000 shares out of a total of 1,500,000 outstanding shares (1 million original + 500,000 new).

This translates to an ownership stake of (500,000 new shares / 1,500,000 total shares) = 33.33% for the investor.

Note: A higher pre-money valuation translates to a higher price per share. This means the investor gets fewer new shares for the same investment amount, resulting in a smaller ownership percentage in your company and lesser equity dilution. This ensures you maintain greater control of your company while securing the necessary funding.

Why is post-money valuation important?

Post-money valuation allows investors and founders to calculate the new investors' ownership percentage based on their investment amount.

Let's say a company is seeking a $1 million investment and agrees to a post-money valuation of $5 million after the investment. This means that after receiving the $1 million, the company's total value is $5 million.

To determine investor’s ownership percentage :

Post-money valuation = $5 million

Investment amount = $1 million

The ownership percentage would be:

Investment amount/Post-money valuation × 100

= 1,000,000 / 5,000,000 × 100

= 20%

So, investors would receive approximately 20% ownership in the company after the $1 million investment, based on the post-money valuation.

The post-money valuation, while not directly impacting your negotiation process, also has an impact on the exercise price of your stock options, if the pool is carved out post fundraise.

In short: Pre-money valuation determines the price per share at which the new investor enters the company and the total number of shares to be issued based on their investment amount and share price. However, ownership stake is ultimately determined by post-money valuation, which reflects the company's total value after the investment has been made.

P.S. Keeping track of pre and post-money valuations across funding rounds is crucial for understanding your company's growth and financial standing. EquityList facilitates this alongside handling other equity related tasks such as tracking and issuing employee grants, etc.