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Overview of Pre-Money and Post-Money Calculations
The value of a business in a funding transaction begins with determining the pre-money and post money valuation. This valuation will be used to determine how many shares are issued to the investor and what percentage of ownership all owners will have following the funding transaction.
Pre-Money and Post-Money Valuation
Pre-money valuation is the value attributed to the company before any new equity is brought into the company via the equity funding transaction. In turn, post-money valuation is the value of the business following the infusion of capital. Therefore, the post-money valuation of the company will equal the pre-money valuation plus the funds injected into the business from the investor.
Calculations Based Upon Pre and Post-Money Valuation
The following equations are important for determining the projected capitalization of a business in a funding transaction.
- Post-money valuation = Pre-money valuation + Investment amount
- Purchase price per share = Pre-money valuation / Number of fully-diluted shares before investment
- Example: Pre-Money valuation is $500 and there are 25 outstanding shares or share equivalents, then the purchase price per share would be $20.
- Number of new shares issued to investor = Investment amount / Purchase price per share
- There is an assumption that the shareholder is investing in the company at the present valuation. As such, if the company is valued at $20 per share and the investor injects $100, she gets 5 shares.
- Number of fully-diluted shares after investment = Number of fully-diluted shares before investment + Number of new shares issued to investor
- In a funding transaction, the investor will generally acquire a new class of shares for her investment. This is generally a form of preferred share.
ESOPs are employee stock option plans or pools. Investors know that a startup company will need to issue shares of equity to hire and retain certain employees. The investor does not want these shares to be authorized later and dilute her ownership interest (i.e., reduce the value of her shares). As such, before the investment, the startup will need to authorize shares as part of the equity pool to be retained for compensating employees.
- Example: There are 25 outstanding shares or share equivalents. The investor wants an equity pool of 5 shares. Before the transaction gets off the ground, the current owner’s ownership is diluted.
- 25 shares = 100% ownership before the ESOP
- 30 shares = 100% post ESOP
- Owner’s interest post ESOP = 25/30 or 83.34%
Post-Money Valuation including ESOP
The price per share of the company is the valuation / fully diluted shares. Now that there are more shares, the price per share to the investor is lower.
- Example: Pre-money valuation is $1,200. The total number of shares including the ESOP is 30. The price per share is $40. If the investor injects $1000 of capital into the business, she will receive 25 shares. The post-money valuation is $2,200 and there are 55 outstanding shares and the price per share is still $40.
How Investors Use Pre and Post-Money Valuation in Negotiations
Investors put money into the company based upon post-money valuation. If an investor says, “I’ll invest $100 for 20% of the business.” The investor is saying that, after the transaction, he wishes to own 20% of a company. He assumes that 20% is immediately worth $100 (and will hopefully grow). This means that 100% of the company must be worth $500 ($100 x 5). As such, the pre-money valuation of the business is Post-Money valuation ($500) minutes the amount invested ($100). In this example the pre-money valuation is $400.
You can now use the above calculations to determine the purchase price per share issued to the investor.