Introduction
In this blog we will cover what is pre-money valuation, why it is important & how it affects your business.
This term may sound complex but it is important for anyone who wants to raise funds for their startup. Understanding this concept can help you attract investors, taking financial decisions & creating an overall plan for your company for future growth.
What is pre-money valuation?
It is the valuation of a company before it receives any new funding. It is the worth of the business based on its current assets, performance & potential.
Let us understand it with an example-
If your startup is valued at 1 million before an investor invests 50000 then the pre-money valuation is 1 million.
This valuation will decide how much ownership the new investors will get in exchange for their investment. If your pre-money valuation is higher it means you will give less equity to investors.
On the other hand if it is lower it might mean giving up more equity in your company.
Importance of pre-money valuation
There are a number of benefits of pre-money valuation as it determines the future financial health of business & overall ownership structure.
Here are some of the most important benefits of it-
Deciding Ownership Stakes
It tells how much equity an investor will get in exchange for their investment.
For example, if a company has a pre-money valuation of 1 million & an investor decides to invest 250,000 then it becomes 1.25 million. Now the investor will own 20% of the company.
This calculation is important for both founders & investors to understand how ownership is divided.
Influencing Future Investment Rounds
No doubt it influences future investment rounds. A high Pre-money valuation shows that the company is growing & positively impacts future rounds.
On the other hand, a lower valuation makes it harder to raise funds.
Negotiating with the Investor
Knowing your pre-money valuation gives you an idea of your business valuation which ultimately helps in negotiating with the investor. When you understand your company’s worth you can confidently justify your valuation to potential investors.
Attracting the Right Investors
Onboarding the right investor is a dream for every business that understands and appreciates the true value of your company. In order to attract relevant investors you will have to understand your business value first so that you can pitch to potential investors confidently.
How to Calculate Pre-Money Valuation
It can be calculated through various methods. Each method offers a different perspective on a company’s total worth which is again based on specific parameters.
Here are some common valuation methods for Calculating it-
Comparable Company Analysis (CCA)
In this method a company is compared with other similar companies that have recently valued or sold. You make comparisons to similar companies in your industry by looking at their revenue, growth rate & market position. It provides a market based valuation that reflects what investors are willing to pay for similar businesses.
Discounted Cash Flow (DCF)
This method is used to estimate the value of your company based on its expected future cash flows. You project the company’s future cash flows & then discount them back to their present value using a discount rate that shows the risk. It is useful for understanding the intrinsic value of your company based on its ability to generate cash in the future.
Venture Capital (VC) Method
This is a common method used by venture capitalists. This method estimates the return on investment by looking at the company’s future value. You estimate the company’s exit value (future sale or IPO) & then work backward to determine the current valuation. It helps in setting realistic expectations for future growth.
Berkus Method
This particular method is used by early stage startups based on qualitative factors. In this method you filter out your company on the basis of competitive advantage, quality of the management team, customer relationships & product sales. It is particularly useful for startups with limited financial history.
Conclusion
Now you have got an idea of what Pre-money valuation & its working principle. How deeply you understand it will impact how much money you can raise & how much of your company you will own after the investment.
It can be calculated by a different valuation method that has its strengths. These methods can be used depending on the stage of your startup. You can also use a combination of methods to get a more accurate valuation.
FAQs
What is an example of a pre & post-money valuation?
Suppose your company is valued at $1 million before receiving any new investment. This 1 million is the pre-money valuation. Now if you got an investment of 500,000 then the total value of your company becomes 1.5 million. This 1.5 million is the post-money valuation.
How do you solve pre-money valuation?
First of all you should know the investment amount & the post-money valuation then you can use the formula-
Pre-money valuation = Post-money valuation −Investment amount
What is pre vs post-money valuation dilution?
Pre-money & posilution is the change in ownership percentage when new shares of a company are issued.
Dilution occurs because the total number of shares increases.
What is the difference between pre-money valuation and post-money valuation SAFE?
A SAt-money valuation dFE (Simple Agreement for Future Equity) is a method for investors to invest money in exchange for future shares.
Pre-money valuation SAFE: The valuation of the company before new investment. Investor shares are based on this valuation.
Post-money valuation SAFE: The valuation of the company after new investment. Investor shares are based on this valuation.
The main difference is the timing of the valuation either before or after the investment which affects the ownership percentage for investors.
