In any venture capital financing round, the venture capital valuation of a company is vital to the success (or failure) of the round. The venture capital valuation of a company is often the subject of a tricky negotiation between a company’s founders and its potential investors. A Priori lawyer can help ensure that your company’s best interests are protected at every stage of the financing. These figures are important because the pre money valuation for a startup and the post money valuation for a startup can have a large impact on the ultimate success of the financing round, and capital is vital to startups and emerging companies.
The Difference Between Pre Money Valuation and Post Money Valuation
The difference between a pre money valuation of a company and a post money valuation of a company comes down to timing. A pre money valuation of a company refers to the company's agreed-upon worth before it receives the next round of financing, while the post money valuation of a company refers to its value immediately after receiving the capital.
Why Does The Difference Between Pre Money Valuations and Post Money Valuations Matter?
The difference between the pre money valuation of a company and the post money valuation of a company matters because it ultimately determines the equity share that investors are entitled to after the financing round is over. For example, if an investor gives a company $250,000 of capital, those investors would receive an equity share of 20 percent if the pre money valuation of the company were set at $1 million. This percentage jumps to 25 percent if the pre money valuation of the company were set at $750,000. This can have dramatic legal and financial implications on the company long after the financing round is over.
The Post Money and Pre Money Valuation Formulas
Determining post money valuation is generally a straightforward task. There are two standard ways to calculate the post money valuation of a company. First, you can simply add the value of the investment to the pre money valuation of the company. Alternately, you can calculate post money valuation by dividing the new investment amount by the number of shares received for that investment and then multiplying that per share valuation by the number of total issued shares post-investment.
Determining pre money valuation of a company is much more difficult, however. The pre money valuation of a company is a negotiated value that depends on some combination of investor-driven formulas and metrics rather than simple math. Disagreements about the methodologies each party uses to arrive at the pre money valuation of the company can lead to heated negotiations. Typically, the parties consider a number of factors when determining pre money valuation of a company. Factors can include recent comparable offerings, exit value calculations, historical cash-flow, and company performance. In addition, the valuation of pre revenue companies is often hotly contested; determining the pre money valuation of a startup can be exceptionally difficult.
Because the venture capital valuation of a company is so important, founders and investors often engage in heated negotiations over the pre money valuation of a company. These disagreements are oftentimes difficult to resolve. When securing a first round of financing, it can be especially tricky to determine the pre money valuation of a company, as the true value of the product is unclear and the parties may even be asked to agree on the valuation of pre-revenue companies. In these cases, convertible notes (also known as convertible debt) can be helpful.
Convertible notes are a financing vehicle allowing startups to raise capital while delaying valuation until a later date when the company is more mature. These notes are structured as loans, but they convert to equity at a later round of funding. Usually, investors get special assurances or warranties in exchange for taking on the risk of an unspecified valuation.
Depending on the particulars of your situation, the legal costs associated with drafting and negotiating the required documents for a financing vary widely. When you hire a lawyer through the Priori network, hourly rates start around $185 per hour for a financing lawyer, but they can run significantly higher than this rate based on whether the lawyer also has certain specific types of experience. In order to get a better sense of cost for your particular situation, put in a lawyer request, schedule a complimentary consultation, and receive free price quotes from our lawyers.
Is the pre money valuation for a startup or the post money valuation for a startup more important to me as a founder?
Ultimately, both the pre money valuation for a startup and the post money valuation for a startup are important. The two valuations of the company work together to determine your company’s value after the financing round is complete. It is important to remember, however, that the pre money valuation for a startup can have a greater impact on ownership percentages after the financing round is complete.
Won’t financing dilute my share in the company?
Yes, but this isn’t always a bad thing. With each round of capital that you raise, your ownership stake in the company decreases. This dilution, on the other hand, is often the key to growing your company and increasing the valuation of your company. A startup needs capital to scale its business, so sometimes diluting your share of the company can drastically increase the value of each share. In the end, it’s up to you and your partners to decide whether or not the capital is worth the ensuing dilution. Talking over the financial and legal implications of this decision with a corporate lawyer can often help you plan your business strategy.