Most entrepreneurs have a similar goal of creating long-term, profitable growth when it comes to building businesses. Yet, whether you’re just getting off the ground or looking to scale significantly, obtaining financing is a necessity.
Taking investments from angel investors or venture capitalists (VCs) means you need to get familiar with how much your company is valued at, which happens in two different stages: a pre-money and post-money valuation. The main difference between the two is the stage of the funding process you’re in—pre-money valuation occurs before raising external funds while post-money takes place immediately after the investments.
What’s the Difference Between Pre-Money and Post-Money Valuation?
This table provides a basic outline distinguishing pre- and post-money valuation, which we’ll explain further below.
|Pre-Money Valuation||Post-Money Valuation|
|Value before an investment is made or the next round of funding takes place||Value after the most recent investment is made|
|Founders own 100% of the pre-money valuation||Various investors have a share of the post-money valuation|
|Calculated from the post-money valuation, determining what the company is worth before the investment||Calculated from an investor’s offer or investment terms|
Post-Money Valuation Explained
A post-money valuation uses the VC’s understanding of your business to determine the overall value. That is why finding the right investor and the best offer takes time for many entrepreneurs as they are looking for the individual who sees the potential scale and is willing to risk capital for it.
Pre-Money Valuation Explained
A pre-money valuation is slightly more complex as it, among other things, uses the post-money valuation from the last round of funding to help determine the value of a business before the next round of investment. In essence, it’s data for future investments that can also be used to determine a business’s growth.
Other factors go into pre-money valuation in order for entrepreneurs and investors to arrive at favorable terms. This includes the current market conditions and valuations of other businesses in the same industry. For more mature businesses, items like pre-money revenue are also included in this list.
All the above considerations can lead an investor to determine the percentage of ownership and the cost of that percentage. This, in turn, is what gives you a pre-money valuation before an investment is made.
Determining your pre and post-money valuation is crucial as a simple balance sheet doesn’t account for the intangible value of a business. Tangible value points, such as assets and cash, are a great start in identifying value, but this is missing the value you bring with your brand name, patents, customer relations, and more.
Let’s say a VC offers to invest $500,000 with 10% ownership in your business. Arriving at the post-money valuation is fairly straightforward:
- $500K is the value of 10% of the business.
- Each 10% of 100% equals $500K.
- The total value of the business is $5 million ($500K times 10).
Your post-money valuation on this investor offer would be $5 million. But before you make the investment, you can use the offer to determine the pre-money valuation of the business.
- Your business is worth $5 million after receiving $500K in investment.
- $500K subtracted from $5 million puts you at $4.5 million.
- That means the business before investment (pre-money) is worth $4.5 million.
This example shows how the addition of tangible and intangible value you create for your business—not just the amount of cash in the bank—can be crucial in determining overall value.
Which Is More Important for a Business?
Both a pre- and post-money valuation are important for successfully raising funds—but for different reasons.
A later-stage startup may be more interested in a post-money valuation as it looks toward going public and selling shares of the company beyond just venture capitalists. Further, the later the stage, the more important it is to ensure your investors, like angels or VCs, are seeing at least 5x return on investment (ROI), or a 25% rate of return, in a few years’ time.
Early-stage businesses may find more importance in pre-money valuation and the opportunity inherent in their business. Earlier stage businesses are often bringing in smaller, seed investments from multiple parties, including friends and family.
Each smaller investment made contributes to your pre-money valuation, which can make your business more attractive to investors like VCs and angels.
A pre-money valuation can be the selling point for an investor, communicating the opportunity a business has created. On the other hand, a post-money valuation represents a business’s ability and need to scale in order to create enticing ROI for investors.
The Bottom Line
The post-money valuation pushes your company into a place of scalability after an investment is made. The pre-money valuation represents the tangible assets, intangible assets, and sweat equity (bootstrapping, concepting, personal risk, etc.) you’ve put into the business. Both pre- and post-money valuations are key in your funding discussions with potential investors, so make sure you’re familiar with both and ready to review the terms of investment.
Frequently Asked Questions (FAQs)
How do you conduct a pre-money valuation?
Once investors offer a price for a percentage of your business, here are some steps to follow:
- Multiply that price until you hit the 100% mark to arrive at the post-money valuation. For example, an investor offers $100,000 for 20% ownership. You need to multiply $100K by 5 (20% x 5 = 100%) to arrive at $500K.
- Subtract the post-money value from the investment offer to arrive at the pre-money valuation. $100K subtracted from $500K makes a pre-money valuation of $400K.
Which is calculated first, pre-money or post-money valuation?
The post-money valuation is calculated first in order to arrive at the pre-money valuation, or value before the investment is made. Many entrepreneurs go into investment discussions with a post-money valuation in mind and negotiate with investors, using a percentage of ownership as a way to entice investment. With a post-money goal in mind, you could create a starting place for a pre-money valuation from the outset.