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Pre-Money vs. Post-Money Valuation
When a company decides that it must raise capital, a key
question that must be answered is how much the company is worth.
For example, if the business needs $500,000 to get started
and/or grow, how much of the equity in that company should
$500,000 command? Once this question is answered, the company
will go out and try to find investors. When doing so, a key
question often arises as to whether the valuation is "pre-money"
or "post-money."
"Before the money" or "pre-money" and "after the money" or
"post-money" denote simple concepts. However, these simple
concepts can even confuse even the most sophisticated analysts
at times. If a company is valued at $1 million on Day 1, then 25
percent of the company is worth $250,000. However, there may be
an ambiguity. Suppose the company and the investor agree on two
terms: (1) a $1 million valuation, and (2) a $250,000 equity
investment. In this case, the company may offer the investor 250
shares for $250,000. Immediately there can be a disagreement.
The investor may have thought that equity in the company was
worth $1,000 per percentage point, in which case $250,000 gets
250 out of 1,000 shares or a 25% equity position.
Conversely,
the company may have believed that the investor was contributing
to the enterprise which was already worth $1 million. Under this
rationale, the $250,000 would give the investor 250 shares out
of 1,250 shares or a 20% equity position.
The critical issue was whether the agreed value of $1 million to
be assigned to the company was prior to or after the investor's
contribution of cash (pre-money) or post-money.
In the above case, a pre-money valuation of $1 million and a
post-money valuation of $1.25 million were equivalent. Because
mixing up the terms could significantly increase the cost of
capital raised, companies must be sure to understand the two
metrics and agree with investors to the metric that raises them
the capital at the appropriate price.
About the author:
GT Business Plans has
developed over 200 business plans for clients that have
collectively raised over $750 million in financing, launched
numerous new product and service lines and gained competitive
advantage and market share. GT Business Plans is the sister site
of GT Venture Capital.
Written By: Dave Lavinsky