Pre money vs post money, which one do you need for your startup and at what stage?
If you are running a business and wondering whether it is worth your time to undertake pre-money or post-money valuations, think no further and keep reading.
The truth is both of them matter to a considerable extent as these values are what will ultimately determine how much of the firm an investor will buy for a certain investment and the percentage of the company the current stockholders will keep.
Your startup's valuation changes drastically over different stages, and every investor wants to ensure they are not overpaying, overvaluing, or endangering their financial stability by taking unnecessary risks. This is why learning about valuations is a must for every startup looking to pitch to investors in order to provide them with a clear and accurate representation of their business's stature. It's highly recommended to use a financial modeling consultant who can support you in the valuation of your startup.
We advise you to read the article till the end to understand the difference between pre-and post-money valuation and how to calculate them.
Pre Money vs Post Money: The Differences
The most significant difference between pre-money and post-money is the timing of investment. Pre-money valuation is determined prior to the investment round, whereas post-money valuation is determined after the round is completed.
In simple words, pre-money valuation is the value of a company before it receives external funding or the most recent round of funding. It is the approximate worth of a startup before it begins to receive investments into the company. Before a funding round, a potential investor will be given this value to represent what the firm is currently worth.
The founders and other existing shareholders of the startup often set the pre-money valuation in which they do not consider any new capital expected to be raised from investors in accordance with an official agreement. However, the pre-valuation is largely impacted by the growth of employee share open plans, debt-to-equity conversions, pro-rata participation rights, and, of course, the value and market opportunity that current stakeholders and founders see. It's recommend to learn the tricks how to make most out of your pre-seed funding round.
What Does Post Money Mean?
On the other hand, a post-money valuation is a company's expected value after receiving outside investment or funding. As the whole new funds are added to the pre-money valuation to form the post-money valuation, it is much higher than the previously determined one. They have a more fixed price depending on the company's actual financial worth.
However, there is something a startup should be careful about. After obtaining several investments, if the post-money valuation declines from the prior round—referred to as a "downr ound"—it may indicate that the company is in crisis. When the financial situation is really severe, it could be difficult for businesses to get or keep investors. The investors could, however, turn a profit rather than a total loss if they see that their capital investing in a down round can help the startup eliminate the risk of impending bankruptcy.
Difference between Pre Money and Post Money SAFE
SAFE stands for Simple Agreement for Future Equity. It is used as a mutual agreement between the investor and the company.
Understanding "Valuation-Cap"is essential for understanding the primary distinction between pre-money and post-money SAFE. A valuation cap is a method for calculating the conversion price per share in SAFE agreements, which is the price the investor would pay for each share upon conversion of the SAFE. It determines the maximum price at which your convertible security will convert into equity.
- When valuing a pre-money SAFE, the shares issued upon conversion of the SAFEs are not included in the calculation of the company's value (SAFEs and convertible notes).
- In post-money SAFE, however, the company's valuation also takes into account the shares that will be given after funding.
In short, pre-money SAFEs calculate the conversion price per share based on firm capitalization without incorporating the shares to be issued following SAFE conversion. It means that the ownership of earlier investors will be diminished with each subsequent investment. On the other hand, the shares that will be issued upon conversion of SAFEs are already accounted for in the company's capitalization in post-money SAFEs.
As a result, it makes sure that shareholders, rather than SAFE holders or investors, bear the cost of ownership percentage dilution. Pre-money SAFEs can be advantageous to startup entrepreneurs as they enable them to obtain pre-valuation funding similar to a convertible note.
Calculating Pre-Money and Post-Money Valuations
Now, let’s move on to the valuation part with pre money vs post money example. Related to the next lines it makes sense to understand how investors make investment decisions.
Though it can be challenging, determining a pre-money value frequently involves more calculations and ratios than it does in your and your investors' perceptions about the firm. It depends on the market i t competes in and the likelihood that it will flourish in the future.
It comprises a variety of things to think about, such as the stage of the startup life cycle your firm is in and howseasoned and well-known you and your founders are in the market. In addition,any number of additional measures, including cash flow, expenses, income,sales, clicks, engagements, page views, users, subscribers, listens, and upvotes, are also considered.
Another simple way to calculate pre-money valuation is by first letting the investors determine a post-money valuation. Since they are determining a post-money valuation of $250,000 after an investment of $50,000, it automatically makes the pre-money valuation to be$200,000. This calculation can be done with the help of the following formula:
Pre-money valuation = Post-money valuation - Size of investment
It is considerably easier to calculate post-money valuation, and it can be done in two ways:
You just have to add the investment amount to the pre-money valuation.This valuation can be computed using the formula below:
Post-money valuation = Pre-money valuation + Size of investment
For example, consider a business with a pre-money valuation of $200 million. A venture capitalist invests $50 million in the business. By adding the pre-money valuation of $200 million plus the investor's $50 million, you will get a resultant $250 million post-money valuation.
Look at the share price you agree to sell at – this is the amount of the investment. Divide this by the number of shares that the investor has.
Share price = New Investment /Number of New Shares Received
Since share price is also determined by the number of shares an investor receives after investing divided by the entire post-money valuation, we get the following formula by substituting the amounts:
Post-money valuation / overall number of shares after investment = New investment amount/number of newly obtained shares
If we rearrange, we can also determine the value by
Post-money valuation = product of the number of shares received after the investment + new investment amount