Generally, the valuation of a company entails determining its economic value. In doing this, the founders analyze all aspects of the business, including the company’s capital structure, management, future earnings, and the market value of its assets. Usually, a company valuation is carried out when a company needs more funds to run the company. Other instances that require valuation are when a merger is being considered or a sale of part or all of a company.
For companies aiming to raise more funds to run their business, the co-founders should get familiar with the worth of their company before and after a financing round through its pre-money and post-money valuations. Doing this contributes to the success or failure of fundraising as it influences investors’ equity share.
Generally, pre-money and post-money valuation both refer to the company’s valuation. However, the difference lies in the timing of the equity valuation. Pre-money valuation refers to the equity value of a company to a potential investor before raising capital in upcoming financing. It shows the current worth of the company before investment from investors. In contrast, post-money valuation is the implied value of a company’s equity after receiving investors’ funds. These valuations of a company are not static as they change over time with each financing round.
Why does the difference matter?
In the long run, understanding the difference between pre-money and post-money valuation is essential because it influences the equity share that investors are entitled to after the financing round. Illustratively, FutureAfrica, an investor, gives a company $500,000 worth of capital.
It would receive an equity share of 20 percent if the company’s pre-money valuation were $2 million. This percentage would have been 25 percent if the company’s pre-money valuation was at $1,500,000. Consequently, this shows how valuations affect the equity share of investors.
The Post Money and Pre-Money Valuation Formulas
The most straightforward formula for getting a post-money valuation is to add the company’s pre-money valuation to the value of the investment.
Mathematically, post-money calculation = premoney valuation + amount raised.
Alternately, where the pre-money valuation is unknown, you can calculate a post-money valuation by dividing the new investment amount by the number of shares received for that investment and multiplying that per share valuation by the number of totals issued shares post-investment.
Post-Money Valuation = Financing Raised / % Equity Ownership * total issued shares
It is pretty complex to determine the pre-money valuation. It is a negotiated value that depends on some combination of investor-driven formulas and metrics rather than simple math. Some factors include recent comparable offerings, exit value calculations, historical cash flow, and company performance.