The concept of pre-money valuation vs. post-money valuation can be a confusing one at first for many startup founders. Pre-money valuation refers to the valuation of the company prior to the investment whereas post-money valuation refers to the value after an investment has been made.
Most founders, when they think of the concept of valuation are referring to pre-money valuation. But calculating pre-money valuation is not intuitive or straightforward. When most people talk about an investment in a startup, usually the investor will say “I’ll give you $2 million for 10% of the company.” What is the implied pre-money valuation in this example? You might think the answer is $20 million, but that is actually the post-money valuation, not the pre-money valuation. To get the pre-money valuation, you need to first calculate post-money valuation and then back into the pre-money valuation.
Calculating post-money valuation is straightforward. You take the dollar amount of the investment and divide it by the percent that the investor is getting. In our example above $2 million is divided by 10% yielding a post-money valuation of $20 million.
But prior to the $2 million investment, the company is not worth $20 million. This is because once you add $2 million worth of cash to the company’s balance sheet the company has just increased in value by $2 million. Therefore to calculate the pre-money valuation you need to take a second step which is to subtract the amount of investment from the post-money valuation. In the example above, the company is being valued at $18 million. This is calculated by taking the $20 million post-money valuation and subtracting the amount of the investment ($2 million). This calculation results in a value of the company, as it exists today, before the additional funds are received by the company from the investor.
Once the pre-money valuation has been calculated, you can use it to calculate the value per share of the company. To do that, divide the pre-money valuation by the number of outstanding shares, and you will get the current value per share of the company (assuming, of course, that the valuation assigned to the company is accurate).
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.