What is Pre Money Valuation?
Pre money valuation is the valuation of a startup or a company before any investor makes an investment in the company. It is a widely used term in the startup world to specify a company's valuation before a new investor puts in cash.
When an investor is looking to invest in a company, the valuation of the company is an important factor that should be considered. The valuation of a company has a direct impact on the number of shares that the investor will get. Therefore, angel investors and venture capitalists usually use pre-money valuation to calculate what percentage of a company they will own after investing in a company.
Usually, a startup seeking investment hires a valuation agency that will value the company and give a benchmark estimation of how much the company is worth. This usually happens when the company is looking for external funding to grow, expand their team, or pivot to a new idea.
How to Calculate the Pre-Money Valuation?
Pre-money valuation is used to determine the fair market value of a company by taking the proposed investment amount into consideration. This is because the investment amount represents the value that will be added to the company by the investor. Pre-money valuation is also the standard valuation that investors use when they are considering investing in a company. It is called pre-money because there is money invested by the investor before the valuation of the company is finalized.
The calculation of pre-money valuation involves subtracting the total investment from the post-money valuation of a company.
Pre-money valuation = Post-money valuation - Investment amount
In the next section, we explain how to calculate pre-money valuation through an example.
Example of Pre Money Valuation
Consider the founder of a tech company, for example. He runs the company along with his other co-founder. The pair own 100% of the business, which has 1M shares outstanding.
Now, to scale the startup, the co-founders are seeking seed funding for $1M at a 3M post-money valuation.
Pre-money valuation is used by angel investors and VC firms to value the company prior to the investment round. It is used when the company is already earning revenue or has any potential to earn revenue.
Pre-money valuation = Post-money valuation minus the investment amount
So, according to this formula, the pre-money valuation is $2M ($3M - $1M = $2M).
Based on this valuation, each outstanding share of the company is worth $2 ($2M pre-money valuation / 1M shares outstanding).
Per-share value = Pre-money valuation ÷ total number of outstanding shares
Consequently, to raise $1M, they would need to issue 500k additional shares ($2 x $500k = $1M).
As a result, the co-founders will lose their 33% equity stake in the company in exchange for an additional $1M in financing.
Pre money Valuation vs Post Money Valuation
Pre-money and post-money are both valuation measures that determine the value of a company and how much a company is worth. They differ primarily in the timing of the valuation.
Pre-money valuation is the value of the company before the investment has been made. Whereas, post-money valuation is the valuation of the business after the money has been invested in the business.
Let's say an investor wants to invest in a company. The owner and the investor agree that the company is worth $100,000 and the investor will invest $25,000.
Now, based on whether this is a $100,000 pre-money or post-money valuation, the ownership percentages will differ.
If the $100,000 valuations are pre-money, then the company is valued at $100,000 before the investment and after investment will be valued at $125,000.
If the $1 million valuation includes the $25,000 investment, it is referred to as post-money valuation.
The valuation method used can have a major impact on the ownership percentages. Based on the table, the investor holds just 20% of the company while using a pre-money valuation, but he or she holds 25% when using a post-money valuation. It is due to the amount of value placed on the company before investing. A small percentage of 5 percent of ownership may not seem like much, but if the company goes public, it could be worth millions.
In general, a company is valued higher if it's valued pre-money, since the valuation does not include the invested amount.
Pre-money valuation: It is the value of a company before any investments or capital infusion.
Post-money valuation: It is the value of a company after any investments or capital infusion.
Pre Money Valuation Calculator
The pre money valuation calculator is an online tool that helps you calculate the worth of your company before it has raised any capital.
The tool calculates the pre-money and post-money valuation based on the investment amount and the investor's equity percentage. You can use this tool to determine the value of your company during the fund-raising process.
Click here to download the Pre Money Valuation Calculator Excel Sheet for free.