A pre-money valuation refers to the value of a company before it goes public or receives other investments such as external funding or financing. Put simply, a company’s pre-money valuation is how much money it is worth before anything is invested into it. The term, which is also simply referred to as pre-money, is often used by venture capitalists and other investors who aren’t immediately involved in a company. This figure allows them to determine what their share in the company is – based on how much they invest.
Potential investors can use the pre-money value of a company to determine how much it’s worth before they invest their money.
Pre-money valuations are different from post-money valuations, which determine a company’s worth after it receives funding or financing.
Pre-money is the valuation of a company before any rounds of financing, and gives investors a picture of what the company’s current value may be. But it isn’t a static figure, which means it can change. That’s because the valuation is determined before each round of financing, whether that’s private or public investment. Pre-money can be determined just before a company is traded on public markets. You can also use the pre-money valuation prior to seed, angel, or venture funding is put into a company.
The pre-money valuation may be a figure proposed by a potential investor. The number could then be used as a basis for the amount of funding they will provide and how much ownership they expect in return. The leadership of the company might reject pre-valuations proposed by others until they reach an amount that matches the aspirations of the company.
Calculating the pre-money valuation for a company is fairly easy. You do, though, need to know the post-money valuation, which is explained a little further down. Here’s the basic formula:
Pre-Money Valuation = Post-Money Valuation – Investment Amount
So a company whose post-money valuation is $20 million after receiving a $3 million investment has a pre-money valuation of $17 million.
Early stage valuations may also coincide with the company being pre-revenue, meaning it has yet to generate any sales. This may be because it doesn’t have a product on the market yet. Investors can still determine the company’s value, basing it on a variety of other factors. One such measure may be comparable businesses. An assessment of the revenue and market value of more established, mature companies with a similar focus and operational approach can serve as a gauge of the potential for pre-money companies.
Even if pre-money companies claim they are creating an entirely new industry with new business models, their prospects will likely be cast in the vein of an earlier business. For example, if a new company plans to produce a new type of automated vacuum cleaner, its pre-money valuation might be established in part by assessing the performance of other makers of robot vacuums. Other factors that may contribute to the pre-money valuation can be the experience and track record of its founders and leaderships, the feasibility of delivering on promised services, and any competition that may arise.
One important thing venture capitalists and entrepreneurs need to consider when they talk about pre-money is to be very careful not to fall into the trap of counting their chickens before the eggs have hatched or, in other words, spending money they don’t actually have.
Investors should make sure they don’t spend money they don’t actually have when they talk about pre-money valuations.
As its name implies, post-money valuation is different from pre-money because it indicates how much a company is worth after it receives an investment. This includes any amount of capital–raised through a public offering or through private, external sources. The post-money valuation is the total of the pre-money, plus the additional equity injected into the company. So, if a company’s pre-money valuation is $25 million and it receives $5 million from an investor, the post-money valuation is $30 million. This is an important figure because investors can figure out how much equity belongs to them after they invest in a company.
Here’s a simple example of the pre-money valuation of a fictional confection shop. Let’s say that Jim’s Fabless Donut Shop is thinking of going public. The owner puts forth the business proposal in the hopes of attracting potential investors. If management and venture capitalists estimate that the company will raise $100 million in the initial public offering (IPO), it is said to have $100 million in pre-money.