Pre Money Valuation
Refers to the value of a company before any new outside investment or financing
Updated:
September 27, 2023What Is Pre Money Valuation?
A pre-money valuation (PMV) alludes to the worth of an organization before it opens up to the public or obtains different ventures like outside subsidizing or funding. An organization's PMV is how much money it is worth before anything is put into it.
The term alluded to as pre-money is frequently utilized by financial speculators and different financial backers who aren't promptly engaged with an organization.
Understanding Pre Money Valuation
Pre-money is the valuation of an organization before any rounds of funding and provides financial backers with an image of what the organization's ongoing worth might be. In any case, it's anything but a static figure, implying it can change.
That is because the company is still up in the air before each round of funding, whether it is private or public speculation. Pre-money can be resolved before an organization is exchanged in open business sectors.
One can likewise utilize this valuation before seed, Angel, or venture funding is funded into an organization. This valuation might be a figure proposed by a possible financial backer.
The number could then be utilized for how much financing they will give and how many proprietorships they expect.
The organization's administration could dismiss pre-valuations proposed by others until they arrive at a sum that matches the organization's desires.
These valuations are mostly used for startups, as startups conduct many rounds of funding to raise funds from private investors to meet their operational needs. The calculations of pre-money and post-money valuations for each round of funding ease investors' risk.
The formula is as follows:
Pre-Money valuation = Post-Money Valuation - Investment Amount
Where,
Post-Money Valuation = New Investment * (Total Post Investment Shares Outstanding / Shares Issued For New Investment)
Pre-Money Valuation Methods
There are a couple of measurements financial backers use while proposing a PMV when financials are not promptly free. They are as per the following:
1. Comparable Businesses
This depends on a correlation of the organization to other more settled organizations in the commercial center. They will quantify the income and market worth of more experienced organizations to measure a startup's true capacity.
2. Founding Team
Good founding teams are individuals who get things going as they need, have sound regard for the real world, and are determinedly creative. Founders who have a fruitful history of sending off new organizations and have gathered a group of shrewd individuals around them appeal to VCs.
3. Deal Interest
If a ton of financial backers need to partake in an arrangement, the organizers have influence. They can drive up the organization's valuation, permitting them to hold more possessions. As it may, assuming an arrangement is undersubscribed (i.e., low interest), the financial backers can direct the organization's valuation.
Pre Money vs. Post Money Valuations
Pre-Money and Post-Money are often heard together, so it becomes important to know their differences. Post-Money valuation is simply the addition of pre-money valuation and the amount of cash input into the organization during the fundraising.
Pre-Money Valuation = Post-Money Valuation - Investment Amount.
If a company's pre-money valuation is $5M and raises $2M in fundraising from financial backers, its post-money valuation is said to be $7M.
Post-money valuation determines the ownership of an organization's founders or investors. If a company raises $10M from investors at a pre-money valuation of $25M then the ownership of the investors comes out to be 28.6% (($10M / $35M)*100 = 28.6%).
Similarly, if a company raises $10M at a post-money valuation of $25M then the ownership of investors comes out to be 40% (($10M / $25M)*100 = 40%).
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Pre Money Valuation Impact
PMVs sway a ton of arrangement terms. Since then, this valuation is not entirely clear; financial backers ordinarily demand preferred shares in the organization as a defense against overvaluation.
Preferred shares give financial backers a few possible advantages, including a liquidation inclination, interest freedoms, and a hostile to weakening privileges.
Due to these freedoms, preferred shares are, for the most part, more important than normal stock held by originators and workers.
If the authors and financial backers can't settle on a pre-money valuation and there is still venture revenue, the originators could give convertible notes to financial backers.
Convertible notes add up to a credit presented by financial backers that can change over to preferred stock at a later subsidizing round when a valuation might be simpler to decide.
Navigating Pre-Money Valuation Dynamics
These valuations are emotional, meaning the exchange interaction is critical. Strong communication and bartering techniques could allow a company to claim a sizable piece of an organization with tremendous potential.
One would rather not solid arm organizers into an uncalled-for valuation, as this can set a poor base for a relationship now and down the road.
As a private backer, remember that this valuation will probably be weakened in future financing adjustments as the pre-money valuation develops and bigger VCs reach out.
This is not something awful as an organization's PMV builds, the share cost increases.
Two factors need to be kept in mind while deciding on such valuation for a company-
1. Dilution of Shares
Dilution of shares tends to cause a loss to initial shareholders' investment in many ways-
- Some venture debts taken by a company to meet its operational requirements have provision for conversion into shares, eventually leading founders and initial shareholders to dilute their stake.
- A company issues employee stock options as an incentive to its employees. When such options are vested, it leads to dilution of shares by initial shareholders.
- If a company raises capital to meet its funding requirements, it issues more shares, decreasing the shareholding of existing shareholders.
2. Revenue of the company
- The valuation of a company is very much dependent on its revenue. Therefore, it is very difficult to value a company with pre-revenue or no revenue and companies with net cash burn.
PMV and 'up round', 'down round' funding
Before raising capital, the PMV is not entirely set in stone by existing investors, mostly the organization's founders.
The contrast between the starting valuation and the consummation valuation following the round of funding decides if the supporting was an "up round" or a "down round."
An "up round" signifies the valuation of the organization bringing capital has expanded up in contrast with the earlier valuation.
A "down round" implies the organization's valuation has diminished present funding in examining the first round of support.
An organization can unquestionably recuperate from a negative round of funding, notwithstanding the expanded weakening among investors and expected struggle under the surface after the fruitless round of support.
While many inquiries (and questions) are sure to be raised about the organization's fate and bringing capital up, later on, will become undeniably seriously tested, the capital brought up in a down round might have disposed of the gamble of inescapable insolvency.
Albeit the chances are reasonably stacked against the organizers, the capital might have given it sufficient opportunity to turn the business around. For example, the funding was the lifesaver that the startup expected to stay above water for the present.
Factors Affecting PMV
This valuation is frequently attached to a monetary valuation of the organization. However, PMV is eventually shown by the exchange between the organization and the financial backers. In funding financings, financial backers frequently propose a PMV subject to specific necessities, for example,
- The number of securities accessible to be allowed under an organization's equity incentive plan as a level of the post-fund raising fully diluted capitalization of the organization.
- Specified share vesting provisions occupied by founders of the company.
The last arranged esteem came to the parties and utilized in the price estimation ordinarily factors any current inconsistency or inability to fulfill any of these necessities. Different variables can likewise influence the discussions over the valuation.
Variables increasing the valuation are
- Exorbitant premium from multiple financial backers.
- Great founding members.
- Anti-dilution protection favors the investors.
Variables decreasing the valuation are
- Dull interest from the investors.
- Great quality investors.
- Higher risk-return ratio.
- Explicit company dangers.
Pre Money Valuation Example
Let's take the first example:
Consider a company wanting to raise seed funding from investors. The founder of the company holds 100% equity shares. The total outstanding shares of the company are 1 million. The company has set a PMV of $5M.
The company raised $1M by issuing 200K new shares to the investors. In this example, we will find the role of PMV in determining share price, percentage dilution, etc.
According to the data given, the pre-fundraising share price of the company will be:
Share Price = Valuation / Total Shares
= $5M / 1M = $5
Total outstanding shares post fundraising = 1M + 0.20M = 1.2M
Post-money valuation = $5M + $1M = $6M
Post fundraise share price = $6M / 1.2M = $5
Post fundraise founder ownership = founder shares / total shares = 1M / 1.2M = 83.33%
Percentage dilution of shares by founder = 100% - 83.33% = 16.67%
To understand it clearer, we'll take another example below:
Consider a company with a PMV of $100M and total outstanding shares equal to 2M. The founder of the company has 35% ownership. The company raised $52M in a fundraising round from investors issuing 1.04M shares to the investors.
In this example, we will calculate post-money valuation, post-fundraise share price, founder's shareholding percentage, and percentage dilution by the founder.
Total outstanding shares post fundraise will be -
2M + 1.04M = 3.04M
Post-money valuation = $100M + $52M = $152M
Share Price Post Fund Raise = Post-Money Valuation/ Total Shares
= $152M / 3.04M = $50
Pre fundraise founder's ownership - 35%
2M * 0.35 shares = 0.70M shares
Post fundraise shares of founder = 0.70M (unchanged)
Founder’s Ownership Post Fund Raise = (Founder’s Shareholding/ Total Shares) * 100%
= (0.70M/ 3.04M) * 100% = 23%
Percentage dilution of founder’s ownership = 35% - 23% = 12%
Conclusion
The phrase pre-money valuation is widely used in the corporate world. However, it is predominantly used for private companies during the fundraising process.
Correct determination of this valuation is very important as it determines how much money an investor will invest in the particular organization.
It also determines how much shareholding will be retained by the existing investors. Thereby, it also helps in determining the correct valuation of an organization.
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