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When your startup company raises capital, valuation is a key question that must be tackled Rey Maualuga style. (If you are unfamiliar with “Rey Maualuga style,” click here for a Youtube example.) The two main valuation concepts in a venture capital financing are pre-money and post-money valuation.
In a venture capital transaction, the venture capital firm invests cash in the startup company in exchange for newly-issued (preferred) stock. The startup company’s value immediately before the funding is called “pre-money valuation” while the startup company’s value immediately after the transaction is called “post-money valuation.” (Technically, pre-money and post-money are more about price than a startup company’s valuation.)
Pre-money Valuation and Post-money Valuation Equations
(1) Pre-money Valuation = Post-money valuation - Venture Capital Investment
(2) Post-money Valuation = Venture Capital Investment/Venture Capital Ownership Percentage
You can determine share price by the following equation:
(3) Share Price = Pre-money Valuation/Number of Pre-money shares.
You can determine how many shares to issue the venture capital firm by this equation:
(4) New Shares Issued = Venture Capital Investment/Share Price
Pre-money Valuation and Post-money Valuation Examples
Example 1
Let’s say Google’s new venture fund comes to you and offers to invest $3MM into your startup for 30% of the company. Plugging the numbers into equation (2), we get:
Post-money valuation = $3MM/.30 = $10MM
Thus, to calculate pre-money valuation, we use equation (1) as we now know the post-money valuation and the investment amount:
Pre-money valuation = $10MM - $3MM = $7MM
Example 2
Now let’s say a venture capital firm offers your startup company a $4MM investment at a $6MM pre-money. To determine how much your startup would give up in exchange for the $4MM, we use equation (1) and get:
$6MM = Post-money valuation - $4MM, and solving for Post-money valuation (Post-money = Pre-money + Investment) gives us $10MM
Next, we use equation (2) to find the Venture Capital firm’s percentage:
$10MM = $4MM/Venture Capital Firm Ownership Percentage (VCFOP), solving for VCFOP (VCFOP = $4MM/$10MM) we get 40%.
August 08, 2008 at 5:26 pm
So, if an angel wants 5% of my company, assuming I had one.
And that angel is willing to invest $15,000 for that 5%.
Working backwards to find post-money value…
Given, post money = pre-money + investment.
Then,
Post-money = $300,000
Pre-Money = $285,000
Investment = $15,000
So, angel’s 15,000 investment just bought him 5% of the company (15 / 300).
Then Pre-money value = price of shares * value of shares before financing.
For 500,000 shares, $285,000 = $0.57 * 500,000, or
For 1,000,000 shares, $285,000 = $0.28 * 1,000,000
Does that look right?
So, by an angel saying they are willing to invest $15k for 5% into my imaginary company, that angel has just defined a post-money value (and pre-value) for my firm.
By extension, can my wife invest $500 in my company for a post-money 0.5% interest, that would cause my post-money value to = $100,000 ( = 500 / 0.5)? I would own 99.5%, or $99,500 (pre-money) with no cash invested, and she would own 0.5% with $500 cash invested?
August 14, 2008 at 1:45 am
Jim,
I re-wrote the post to (hopefully) make it more clear. I think your calculations look good.
August 14, 2008 at 2:16 pm
Thanks. I think this works, in some regards, if the stock is issued after initial seed funding, or as a result of it. For example:
Pre-seed angels invest $15k for 15% of the company, which would value it at $100k (= 15k/0.15)
Then issue 1,000,000 original shares at a value of $0.01 per share so that now my angel owns 150,000 shares (and 15%) and I own 850,000 (85%).
THEN, if we went to YC (Y Combinator) for add’l funding, say $20k, it would look like:
Prevalue = $100,000
YC investment = $20,000
Post value = 100,000 + 20,000 = 120,000.
YC ownership 20/120 = 17% current ownership.
Pre-seed investm’t = 15/120 = 12.5%
My ownership interest = 85/120 = 71%
For the 20k investment by YC, 200,000 new shares would have to be issued, which then dilutes everyone’s ownership.
I think that’s right.