Pre-Money vs Post-Money Valuation, what’s the difference?

Pre-Money vs Post-Money Valuation, what’s the difference?

When a startup raises money from investors, one of the key considerations that needs to be negotiated is the valuation of the company.

You might be wondering, what does it mean for a company to have a valuation?

Simply put, a company will have a valuation when it issues equity to investors. This is referred to as a “priced equity” round. 

In a priced equity round, investors will give money to a startup in exchange for shares in the company. Each share will have a value, known as “price per share (PPS)”; therefore, the company as a whole will be valued based on the number of outstanding shares and the agreed-upon PPS. 

A company’s valuation has tremendous implications for both the investor and the company’s existing stakeholders affecting how much an investor will acquire for a given investment, as well as dilution of existing shareholders, the company’s future growth trajectory, subsequent financing rounds, and more.

Valuation can be measured in terms of ‘pre-money” or “post-money” valuation - the difference comes down to when to value new investor capital.

Below, we’ll dive into the differences between these two valuation frameworks and explain why each one is used.  

What does pre-money valuation mean?

A company’s pre-money valuation is the equity value of a company immediately prior to a new investor’s investment. This valuation does not include any investments made in a current financing round. 

This valuation is agreed upon by the investor and company and is often highly negotiated between the two parties. Valuations are ultimately the combination of market forces, comparative fundraising rounds, and a company’s growth rate, among other factors. Rather than being an exact mathematical calculation, a start-up’s valuation involves many discussions and is typically quite speculative.

How does a company’s pre-money valuation impact current and existing investors?

A company’s pre-money valuation has the largest impact on the price per share (PPS) calculation that investors will be purchasing company equity at. All else equal, a company’s pre-money valuation and the PPS are directly proportional - as one value increases, so does the other. This determines how many shares an investor will own for their investment, the portion of the total company the investor will acquire, and all other shareholder’s relative ownership after a financing round is conducted. The higher the pre-money valuation (and therefore, the PPS), the less that existing shareholders will be diluted. The opposite is also true. The next largest impact on the PPS that investors will acquire their equity stakes at is called the fully diluted capitalization of the company. A company’s fully diluted capitalization is the second factor used to arrive at the PPS that an investor will pay for their shares. The purpose of this metric is to consider any and all existing shares, as well as any and all shares authorized to be issued in the future. The PPS and fully diluted capitalization are indirectly proportional - as one increases, the other decreases.

Exactly what is included in the fully-diluted capitalization of a company will be a negotiated topic between the investor and the company as this will directly impact the PPS which influences all relative ownership interests after a financing round. 

What does post-money valuation mean?

The post-money valuation represents the valuation of the company inclusive of the invested capital from the new financing round. The post-money valuation can tell an investor their exact ownership percentage in a company based on their investment. This valuation metric is equal to the pre-money valuation plus the amount of capital invested in the financing round. Calculating the post-money valuation is more straightforward than its pre-money counterpart.

Example: If an investor invests $1M in a financing round for a 10% ownership stake in the company, the post-money valuation would be $10M.

Which one is used more?

Typically, for priced equity rounds, investors will issue term sheets with a pre-money valuation. This makes it clear to the investor and the company what the price per share will be, regardless of the size of the financing round. 

How do priced equity valuations affect SAFEs?

At the earliest stages of a startup’s journey, it’s uncommon for a company to raise money at a priced equity round. Determining the equity valuation of a company at this stage is a difficult task given startups at this stage often have minimal traction and unproven business models. 

Instead, companies often raise capital using an instrument called a Simple Agreement for Future Equity (SAFE) - a promise to give investors equity shares of your company at a later date once an equity valuation is determined. 

SAFEs are also issued using a pre-money or post-money framework. 

Pre-money SAFEs: 

When a pre-money SAFE converts at the next priced equity round, all SAFE investments will impact each other and result in dilution for all SAFE holders. As an investor in a pre-money SAFE, it’s not possible to determine your ownership percentage heading into the next priced equity round. Once the next round occurs, all SAFE agreements will convert into shares and mathematically affect each other. This is the key difference between a pre-money and a post-money SAFE. 

Post-money SAFEs: 

Unlike a pre-money SAFE, a post-money SAFE gives investors and founders more clarity about how much of the company everyone will own going into the priced equity round. As an investor in a post-money SAFE, you effectively lock in the amount of the company you are going to own at the point you make the SAFE investment. If an investor invests $1M on a $10M post-money SAFE, the investor will own 10% of the company as the founder begins to raise their next priced equity round. 

It’s important to note that post-money SAFE investors will still be diluted by the next round’s equity investors. With that said, post-money SAFEs give investors more clarity over their future ownership stake than pre-money SAFE investors have. Additionally, post-money SAFEs are much simpler for the investor and founder. However, post-money SAFEs can result in more dilution for the founder and must be issued thoughtfully to avoid over-dilution during the next priced equity round. 

Which type of SAFE is used more?

Post-money SAFEs are more common because of their benefits regarding ownership clarity and simplicity. With that said, it’s always important to discuss all fundraising activities with your legal counsel to make sure that the type of instrument you use works for your firm.

Takeaways

Pre-money and post-money valuation are two crucial terms in the world of startups and venture capital. They represent the value of a company at different stages of its financing journey. 

While pre-money valuation reflects the company’s equity value before receiving any new external funding, post-money valuation captures its value after the inclusion of new capital from the most recent financing round.

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