Dear reader,
The current VC literature states that pre- and post-money valuations differ with the contemplated aggregate investment amount.
Modigliani miller said that in an efficient market, the value of a firm is unaffected by how that firm is financed (capital structure irrelevance).
What am I missing?
Is the higher post-money valuation explained by the expected increase in profitable projects due to additional funding?
Let's say you have 0 dollars. Then I give you $100. You are now worth $100 more.
That is literally what is meant by post-money
Not sure what exactly you're asking, but post money is just a term people use to include any additional capital that is funded to the balance sheet rather than to sellers. Simple example: pre-money valuation of $110M (all goes to seller save for some fees assuming they own 100% of the business), then another $10M is funded to the balance sheet by the buyer for working capital, strategic growth projects, etc., so post money valuation is $120M.
Has nothing to do with M&M.
This. It’s that simple OP. Not sure why other commenters are feeding your confusion by taking you further down that path.
Then the term "valuation" is used sloppy and is in fact not a real valuation because without improving company operations by just injecting cash ceteris paribus a real EV can not increase (as mentioned in the other comment, EV excludes cash), because a cash injection ceteris paribus does not affect FCF
MM is correct, but different financing rounds happen at different point in times. Differing point in times are the reason to different valuations.
Timing is a good point but doesn't explain why the valuation difference between pre and post is exactly the cash difference (amount of funding). If you step forward in the timeline in discounted FCFs (of expected projects) , the difference between pre- and post-money is very unlikely equal to the funding amount but rather the expected value of a FCF distribution of one period.
Enterprise valuation excludes cash. And I do believe M&M is valid theoretically in all EVs. Otherwise each company, listed or not, can increase their EV by just injecting cash. M&M said, that the NPV of expected future projects doesn't change with changes in the capital structure. Thus pure cash injections are theoretically disjunct from a company’s projects.
Thus, the only way the EV can change post-money is additional cash enabling additional projects that contribute to a company's NPV, thus EV. (Projects that wouldn't be there without additional funding)
Can someone confirm this for me?
Lets take an all equity funded start-up - EV is defined as EV = EquityValue - Cash
So pre money at $5m Equity value and $0.5m of cash, so EV=$4.5m.
Now post money assuming a $1m round, Equity value is $6m and cash is $1.5m, so EV is still EV=%4.5m. ->So M&M applies as the value of the firm (EV) is unaffected by its capstack.
(You probably meant pre-money: 5m Equity Value - 0.5m Cash = 4.5m Enterprise value. And then post- money with 1m of funding: 6m Equity value - 1.5m Cash = 4.5m Enterprise value.) -> Yes, that is how I understand it as well. It shows that theoretically M&M is valid and capital structure irrelevance works. The question outstanding is still: Why does the VC literature state that a company is worth more after receiving cash funding?
M&M Theorem doesn’t state that capital structure doesn’t matter; it outlines a specific situation in which it doesn’t affect valuation in order to highlight the reasons that it does, in fact, impact valuation in the real world.
As far as pre/post-money valuation goes, post-money just equals pre-money plus money. The pre-money valuation used implicitly includes the present value of investment returns for that capital.
Yes, by increasing the share of debt / debt-like instruments with income statement impact the WACC goes down because the interest of those instruments is lower than equity risk (pecking order). The resulting FCFs increase while both, the NPV and EV increase as well. Still.... It does not explain why the post-money valuation is exactly the pre-money valuation plus funding amount. The question remains if the term "post-money valuation" is a real valuation term -> see comments above...
Any VC seniors here? Or do I have to text the author of the book...
What’s the book out of curiosity?
Venture deals by Brad Feld and Jason Medelson
The VC market is anything but efficient. Information / Relationship arbitrage is paramount, and in my view it tends to determine which VCs make it to the top decile for their vintage.
The valuation terminology might be confusing, but it is quite simple. Let me give you an example.
Say a startup's founders have 1M shares at a price per share of $5. Thus it's valued at $5m.
1 year later, a new investor comes in and pays $10m for 1M newly issued shares of the startup at a price per share of $10.
There are now a total of 2M shares. The founders own 50%, the investor owns 50%.
What's the "post-money" valuation of the company?
It's $20m ($10m / 50%).
What's the "pre-money" valuation of the company?
$5m? No. It's post-money valuation - the invested amount: $20m - $10m = $10m.
Essentially the valuation of a startup is just what the most recent investor is PRICING IT at. It has nothing to do with the intrinsic value of the company.
Thanks omegalul. That is helpful. Two points:
(1) Wouldn't you agree that your example aligns with our discussion above where we basically state that while the investor is pricing the company, he/she takes into account additional operational core projects that will now be possible given the additional funding. Thus the pre- to post-money valuation increase of $10m includes $10m of additional operating cash to be adsorbed into core projects (that cannot be deducted from EV because it is not excess non-operational Cash)?
(2) you said that the pre-money valuation was corrected from $5m to $10m after the funding. Would you agree that this correction is due to the general "market" attributing better valuation skills to the VC? Basically saying, the initial valuation from the startup pre-funding couldn't have been correct (due to maybe lack of modeling skills)?
on (1):
Sure, that is definitely taken into consideration. I think for the most part you have your question answered already.
on (2):
Didn't say it was corrected - put it this way; the pre-money valuation of $10m is the implied pre-money valuation during the financing round. How so? Because if you are paying $10m for 1M shares (50% of the company after the financing), you are implying that the other 1M shares that the founders hold are also worth $10m.
Not sure what you mean by general market & valuation skills, I don't see how these have anything to do with it.
Let's take an extreme case. In 2012, Instagram was valued at pre-money $450m, post-money $500m. In the same year, Facebook then bought them at $1b. Going from your statement, would you say that the $450m pre-money valuation was incorrect?
Hope this helps..
Thanks, it does help. With (2) I meant that the first financing round determines the pre-money value and not whatever valuation the founders came up with before. Correct? All in all, thanks for your contribution to the topic.
This thread is getting out of control. Read my answer and that is the way it is clearly defined by 99.99% of the VCs and growth equity/PE firms. All of this theoretical stuff is fine if you want to debate on a forum, but just be careful to not do this ever in interviews - you'll be shown the door real quick
That's was this is - a theoretical discussion.
Holy shit - what a stupid entrenched thread from the OP that just won't back down besides the fact that everyone worth their salt is telling him otherwise.
Its simple - there is the valuation of the company, and then the value of the company + the cash. Its only different than say PE or public equity because in those situations there isn't a cash infusion. The point is to establish a value that one is investing in...and then clearly that value increases if there is extra monies on the balance sheet.
Edit -Also - most VC companies, and especially in the earlier stage aren't really supported by actual valuations per se - its more so seed rounds get x range, series a get y, series b gets z....and so on. Not until much later rounds does valuation really come into play. VCs aren't running DCFs and zeroing in on valuations so early, come on. Not to mention they usually have liquidation preferences / similar structures anyway so its not even a real valuation in many respects.
Edit 2 - to specifically answer your question you're referring to the value of a firm in steady state where capital structure does not matter vs. a new financing round with a cash infusion. Two totally separate topics.
[Holy shit - what a stupid entrenched thread from the OP that just won't back down besides the fact that everyone worth their salt is telling him otherwise.]
Not helpful. This is a theoretical discussion that is trying to explore depth in the topic for a better understanding. And I do believe that the discussion on this topic has some good points.
[Its simple - there is the valuation of the company, and then the value of the company + the cash. Its only different than say PE or public equity because in those situations there isn't a cash infusion. The point is to establish a value that one is investing in...and then clearly that value increases if there is extra monies on the balance sheet.]
I don'y see how the sentence above adds value to the topic on top of what has already been discussed on this topic.
[Edit -Also - most VC companies, and especially in the earlier stage aren't really supported by actual valuations per se - its more so seed rounds get x range, series a get y, series b gets z....and so on. Not until much later rounds does valuation really come into play. VCs aren't running DCFs and zeroing in on valuations so early, come on. Not to mention they usually have liquidation preferences / similar structures anyway so its not even a real valuation in many respects.]
Thats why this is a theoretical discussion about value. As the term "valuation" is used in early stages, it makes sense to include it here into the discussion.
[Edit 2 - to specifically answer your question you're referring to the value of a firm in steady state where capital structure does not matter vs. a new financing round with a cash infusion. Two totally separate topics.]
I don't think the sentence above answers anything.
Yes, clearly you don't think that it answers anything and hence why there is a cognizant breakdown.
I experienced brain damage scrolling through this. Lord bless the OP that he stays in academia
I may have overestimated the quality of this forum...
Real-life example of pre and post money valuation:
One of my advisers/mentors invested in Airbnb back in 2009 at a $2.4 million pre-money valuation - he and Sequoia Capital put in $600k, which means a post-money valuation of $3 million (approximately 20% ownership) in the company.
Airbnb was most recently valued at $35 billion. His 20% stake (actually less, since Sequoia most likely took the bulk of the round) has now been diluted, but even assuming a modest 0.25% stake (not unreasonable since he exercised his pro-rata rights up until a certain valuation) that is $87.5 million... in other words, set for life.
The EV is unaffected by straight forward capital raising. Only equity value is affected.
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