Have you ever wondered how a startup gets valued before it’s made a single dollar? Or how an investment in the company can change its value overnight?
Understanding pre-money and post-money valuation will help you answer these questions.
A pre-money valuation represents the value of a company before it receives any outside investments, while a post-money valuation is the value of the company after receiving investments.
These financial metrics are crucial during funding rounds and can influence the company’s future and investors’ returns.
Let’s explore what these valuations mean, the key differences between pre-money vs. post-money valuation, and why they matter to investors and founders alike.
What is valuation?
“Valuation” is a method of assigning value to a company.¹ It’s a way of calculating its worth at a certain point in time.
Understanding how to value a company helps founders determine how much they should charge investors for a piece, or “share,” of their company. Investors can use this information to decide if they want to invest and how much they should pay.
The valuation of a company (pre-money vs. post-money valuation) also impacts how the price of its shares is calculated. Shares, also known as stocks, represent ownership in a company. The more shares you have, the more of the company you own.
What is pre-money valuation?
Pre-money valuation refers to a company’s value before it receives any initial or new investments. Think of it as a price tag that an investor sees on a business before they decide to contribute their own money.
It values the company at a smaller amount than the post-money valuation.
The pre-money valuation determines the percentage of ownership an investor will receive for their investment.
A variety of factors can influence a company’s pre-money valuation, including:²
- Founders and team members. Companies that have founders and team members with solid track records can help boost your startup’s valuation.
- Intellectual property. Having patented technology, software, or other intellectual property can increase the value of your business.
- Financial performance. If your company is already making money, then your revenue will act as one of the factors in your pre-money valuation. The more money you make, the higher your pre-money valuation.
- Competition. A crowded market can lower a business’s valuation, while a more novel idea may increase its value.
- Market conditions. A market that has a lot of growth potential and isn’t overly saturated can lead to a higher valuation.
- Comparable companies. It’s common to refer to other, more established businesses in a similar space to help determine a startup’s potential.
- Deal interest. If many investors are interested in your startup, this can help boost valuation.
Investors and founders negotiate value based on the company’s perceived potential and existing market data.
The pre-money valuation can also change at different stages of the investment cycle.
For instance, during its initial funding round (also called a “seed round”), a company might have a pre-money valuation of $500,000.
Before the company goes into it’s second round of funding (known as Series A), it might receive an investment of $100,000. This would cause the companies pre-money valuation to increase to $600,000.
What is post-money valuation?
Post-money valuation is what the company is worth after receiving investments.
This valuation helps potential investors understand how much of the company they’ll own after adding their investment to the mix.
For instance, if a company is valued at $1 million and receives an investment of $250,000, the post-money valuation is $1.25 million.
To find out how much of the company the investor will own after they invest, you can use this formula:³
Amount invested / post-money valuation = % equity ownership
$250,000 / $1.25 million = 20% equity ownership
For founders, it’s a measure of the company’s new worth that considers the latest funding boost. So, if the company is worth $1 million and an investor offers $250,000, the companies new worth is $1.25 million.
The post-money valuation assigns the company a higher value than the pre-money valuation.
Key differences between pre-money and post-money
The main difference between pre-money and post-money valuation is timing relative to funding. In other words, it’s about when you calculate the share price.
Pre-money values the company before any new funds are injected into a round of investments, providing a lower value to the company.
Post-money includes these funds in the valuation and assigns a higher value to the company.
Understanding the difference affects ownership stakes, dilution of shares, and investment strategies:
- Ownership stakes. This refers to the number of shares an investor gets in exchange for their money.
- Ownership dilution. This term is also known as equity or stock dilution. Ownership dilution occurs when the company issues new shares to investors, decreasing the equity ownership of the existing shareholders.⁴
- Investment strategies. An approach that guides an investor’s decisions based on their goals, interests, and risk tolerance.
The importance of pre-money vs post-money
The distinction between pre-money and post-money valuation isn’t just technical. It has real implications for business strategy and investor relations.
For startups, securing a favorable pre-money valuation can attract more investment without giving away too much ownership.
For investors, understanding the post-money valuation helps assess the risk and potential return on their investment, as it reflects the company’s adjusted worth.
Example of pre-money vs. post-money valuation
Let’s say you’re looking for investments in your new tech startup. You value your business at $1 million and find an interested investor who offers you $500,000 to get involved.
How to calculate pre-money valuation
The pre-money valuation is simply the company’s value before an investment.
If you know the post-money valuation, you can use the following formula to calculate the pre-money valuation:⁵
Pre-money valuation = Post-money valuation – investments raised
Pre-money valuation= $1,500,000 – $500,000 = $1,000,000.
How to calculate post-money valuation
The formula to calculate post-money valuation is:⁵
Post-money valuation = Pre-money valuation + investments raised
Post-money valuation = $1,000,000 +$500,000 = $1,500,000.
Pre-money and post-money valuation: What's right for you?
Whether you choose to focus on pre- or post-money valuation will depend on your position at the negotiation table and your long-term goals. By grasping these concepts, you can better navigate the complex landscape of venture capital and investment.
Founders may prefer a higher pre-money valuation to reduce ownership dilution.
On the other hand, investors might favor a lower pre-money valuation because it allows them to gain a larger stake in the company as part of their investment.
Since these concepts are complex, consider speaking to a legal professional for more information on what these valuation methods mean and how they can affect you and your business.
Discover more about managing your financial future by exploring Chime’s insights on net worth.