Understanding the difference between pre-money and post-money startup valuations is very straight forward, especially if you have the difference explained to you by someone who is engaged in the startup ecosystem.
As someone who Mentors student entrepreneurs, both at the High School and University level, as well as a number of other people interested in embarking on a journey as an entrepreneur or startup founder I often get puzzled look when I reference a valuation as being pre or post money.
It’s not that these people don’t understand the concept, it’s more like they have never had it explained to them in the first place. While this often isn’t an issue for their stage in the startup life cycle I believe that all startup founders should get clued up on common practices of Angel Investors and Venture Capitalists.
The first part of that puzzle, in my mind, is understanding the difference between a pre-money and a post-money valuation.
To help explain the concept when I am engaged with early stage startup founders and to provide a useful tool for other people wanting to do some “back of the envelope math” I created a handy little Startup Valuation Calculator.
The Startup Valuation Calculator lets you enter two of the following fields, and have the other two auto populate based on the values you entered.
- Investment Amount ($)
- Investors Equity (%)
- Pre-Money Valuation
- Post-Money Valuation
For example if you enter the investment amount of $100,000 and set the investors equity at 7% then the pre-money valuation will auto calculate and show it as ~$1.328m and the post money valuation will be $100,000 higher at $1.428m.
Why It Is Important To Specify Whether It Is A Pre Or Post Money Valuation
As with a lot of things in life the devil is in the detail. In one particular instance I was talking to a new startup founder who was looking to bring on an investor from a more traditional background (think real estate as opposed to startups) and they had offered to invest $500,000 at a $2,500,000 valuation.
Its certainly a respectable offer no matter which way you look at it, but when I asked if that was a $2.5m pre-money or post-money valuation then founder was not sure.
Given the investor was coming from a more traditional background I would assume they were working it out based on a post-money valuation, but there is no way of being certain unless you ask.
So why is this important? Well lets break down the proposal to see:
- If the $500,000 investment was made of a $2.5m pre-money valuation then the investor would end up with 16.67% of the company.
- If on the other hand the investment was made of a $2.5m post-money valuation then the investor would end up with 20% of the company
As you can see this is a fairly sizable difference that all hinges on one or two words when discussing a proposed investment opportunity.
How Is The Pre-Money & Post-Money Valuation Calculated
While its great to be able to jump online and use the Startup Valuation Calculator to work out the pre and post money valuations for a startup based on a given investment proposal, it’s still important to understand what is going on behind the scenes.
In essence the pre-money valuation is the valuation of the startup or company PRIOR to the investment being made in the company.
So if the company is valued at $2,500,000 before the investor contributes any money, that is the pre-money valuation of the startup. When the $500,000 hits the company’s bank account then their asset base has essentially increased by $500,000.
Post Money Valuation
This then allows us to calculate the post money valuation, which is essentially the pre-money valuation of the startup PLUS the amount being invested in the company. So in this example $2,500,000 pre-money valuation + the $500,000 investment, equals a $3,000,000 post money valuation.
Where The Calculations Usually Start
Now typically you won’t get hung up on the difference between the pre-money and post-money valuation when discussing a proposed investment. That’s because one essentially allows you to calculate the other.
It is either a simple addition of the investment amount to the pre-money valuation to get the post money, or a subtraction off of the post-money to get the pre-money.
In reality you will spend more of your time and energy determining the starting point for one or the other. That is to say determining if investor interest is sufficient to raise at a $3m pre-money valuation or a $4m pre-money valuation is where you will focus your attention during negotiations.
You can also come across investors who have mandates for the percent ownership of a startup they need to own for an investment to meet their funds criteria. For example an investor may require that they own 20% of the startup post investment (or post-money). In this case the negotiation will center on the amount of money they will contribute for that stake, with the higher the amount invested the higher the valuation goes.
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Also published on Medium.