Post Money Valuation: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
Post-money valuation is the value of a business after it has received cash as part of a venture capital or angel investment deal. 5 min read
2. Post-money Valuation vs. Pre-money Valuation
3. Valuation and Dilution
4. How does valuation impact investment returns?
5. The Dangers of Post-money Valuations
6. Talk to a Lawyer
7. Helpful Tools
What is Post-money Valuation?
Post-money valuation is the value of a business after it has received cash as part of a venture capital or angel investment deal. This is basically the sum of the pre-money valuation plus the amount of the new investment/equity.
Post-money Valuation vs. Pre-money Valuation
The real difference between the two is that they value the company at different times, although both are valuation measures. Pre-money valuation is the value of a business before getting a cash investment, while post-money valuation is the value after it gets the investment. Pre-money valuation is the value that an investor assigns to your company before they agree to invest, and it helps investors decide how much equity to demand in return for their investment. It is also a way to refer to the company’s stock value before it goes public. These two terms have big impacts on how much ownership the investors and original business owners end up with.
To determine the pre-money valuation, the investor makes a determination of the worth of the company. The investor decides to invest $10 million at a post-money valuation of $30 million which would mean they consider the pre-money valuation to be $20 million. Therefore the formula works like this:
Pre-money valuation = $20,000,000/Outstanding Shares = 1,000,000 = $20 per share
The investor gets new shares when they make an investment. For their investment of $10 million, you need to calculate the number of shares they are entitled to. The formula to use is:
Amount of investment $10,000,000/pre-money price per share $20 = 500,000 shares
The investment is then added to the pre-money valuation to arrive at the post-money valuation
Pre-money = $20,000,000 + investment $10,000,000 = post-money $30,000,000
Valuation and Dilution
One of the most important things you need to understand when seeking additional capital is dilution. Dilution occurs when the owner exchanges shares in their company in return for an investment. Using the numbers we used above, it works like this:
Pre-money – if your business is valued at $20,000,000 and there are two partners, you each likely own 50 percent of the business or $10,000,000 each.
Post-money – your business is now valued at $30,000,000 but your equity remains at $20,000,000 for each partner. Instead of sharing in 100 percent of the value, you have given up 30 percent to the investor.
Each round of financing reduces the portion of equity you own in the company. This should always be a consideration when you are seeking additional financing. On the other hand, the value of the shares goes up each time capital is raised. In many cases, investors will want to have anti-dilution clauses included in their term sheets to ensure their level of participation remains the same in future rounds of financing.
How does valuation impact investment returns?
The other aspect one must be aware of is how the valuation of a company impacts the return on an investment. This is important because if the company were to go public, be sold to another company or merges with another company the investor's share of the company is already established at 30 percent. Again, using the numbers above, while the investor paid $20 per share, if the company is sold for $60,000,000 the investor's portion of the sale would be $20,000,000 their profit would be $20 per share. This is assuming there have been no additional investments which have impacted the investor’s ownership.
The Dangers of Post-money Valuations
One of the dangers of post-money valuations is you can hit a bump in the road and your company may have difficulty raising additional capital. To raise additional capital, your business must reach the level of post-money valuation first. This can occur because sales are not as robust as you anticipate, you lose a key member of your team, or for any reason, business falters. Using the numbers above, this means your company must be valued at $30,000,000 before you can consider raising a new round of capital. This is important to remember because any slow-down in sales can have a serious impact on the growth of your business.
When determining the merits of a valuation – other factors should also be taken into account such as liquidation preferences and dividends. Looking at the big picture will help investors to maximize the return on their investment. Investors may, therefore, want to purchase preferred convertible stock rather than common stock, as this will give them preference in the payment schedule over common shareholders in the event of a liquidation. Additionally, preferred stock allows investors to have vetoes over major decisions within the corporation like choosing or firing a CEO, how much executives get paid, additional debt, issuance of more stock, changes to the rights associated with different kinds of stock, the parameters of the employee stock options and any acquisitions, sales or mergers. Preferred shareholders can also appoint board members which can allow them to influence company strategy.
Methods of business valuation
Traditional valuation methods such as looking at discounted cash flow and price/earnings or price/sales don’t work well for companies which are just starting out as there isn’t enough of a history of revenues and costs and the companies may still be losing money. Investors will either look at recent comparable financings, i.e., similar companies in sector and stage, or at potential value at exit (usually by looking at recent mergers and acquisitions of similar companies) to determine the valuation range of the company. They will then try to keep the price to the lower part of that range when paying for their investments.
Show why there is big potential exit value
Remove any doubts the investor may have by thinking ahead and having suggested solutions ready
Understand similar company valuations and see what you may be missing in companies which are ahead of yours
Try to have more than one investor
Ask for higher valuations – push back if you know your company is worth more
If reasonable, take the deal
Get advice from advisors, your board, and other industry experts to see if your valuation is accurate
Evaluate investors – lower valuation with a better investor is sometimes the better option.