Recently I was working with a few people on a new project we are collaborating on (all hush hush right now) and one of the topics was determining how to place a valuation on the company. While it’s not terribly important at this point, it can become an issue later in the life of the company if we don’t address these issues early. In passing I mentioned pre and post money valuation and got a virtual blank stare over skype. It’s one of those terms that is tossed around a lot in the VC/angel world and a lot of people nod and pretend to know what that means. Fortunately, pre and post money valuation isn’t a terribly complex issue grasp.
In a nutshell, pre-money valutation is better for the entrepreneur and post-money valuation is better for the investor. It refers to how the the shares of a company are valued, before or after the investor adds his money.
Let’s assume that the owners and the investor agree that the company is worth $1,000 and the investor intends to invest $250. If they use a pre-money valuation the company is now worth $1,250 after the investment is made. If they use a post-money valuation then the company is worth $1,000 after the investment is made. The important thing to understand here is what happens to the ownership percentages.
In a pre-money valuation you have this:
In a post-money valuation you have this:
The obvious difference is a loss of 5% ownership for the entrepreneur and a 5% gain for the investor. It may not seem like a big deal, but what would you do for 5% of Facebook right now?
So, how do you determine whether you value your company pre or post money? That’s a tough call and can depend greatly on what the investor brings to the table other than money and the entrepreneur brings to the table other than an idea.
Good explanation, Steve. I think the pre vs post decision is also often driven by how hungry the entrepreneur is, and how lucky he feels to have even one investor show any interest. In a case like that, you can bet it’ll be going post money. 😉
I think for the initial round especially it does come down to an issue of visions and hunger.. If you are 100% convinced of your vision then it’s a lot easier to say no to some deals.. But if you are cash strapped and need to get some help, I have a business at that point right now, it’s harder to hold a hard line in the negotiations.