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Pre-Money
vs Post-Money Valuation
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by:
Dave Lavinsky
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When a company decides that it must raise
capital, a key question that must be answered is how much the company
is worth. For example, if the business needs $500,000 to get started
and/or grow, how much of the equity in that company should $500,000
command? Once this question is answered, the company will go out and
try to find investors. When doing so, a key question often arises as to
whether the valuation is “pre-money” or “post-money.”
“Before the money"" or “pre-money” and "after the money" or
“post-money” denote simple concepts. However, these simple concepts can
even confuse even the most sophisticated analysts at times. If a
company is valued at $1 million on Day 1, then 25 percent of the
company is worth $250,000. However, there may be an ambiguity. Suppose
the company and the investor agree on two terms: (1) a $1 million
valuation, and (2) a $250,000 equity investment. In this case, the
company may offer the investor 250 shares for $250,000. Immediately
there can be a disagreement. The investor may have thought that equity
in the company was worth $1,000 per percentage point, in which case
$250,000 gets 250 out of 1,000 shares or a 25% equity position.
Conversely, the company may have believed that the investor was
contributing to the enterprise which was already worth $1 million.
Under this rationale, the $250,000 would give the investor 250 shares
out of 1,250 shares or a 20% equity position.
The critical issue was whether the agreed value of $1 million to be
assigned to the company was prior to or after the investor's
contribution of cash (pre-money) or post-money.
In the above case, a pre-money valuation of $1 million and a post-money
valuation of $1.25 million were equivalent. Because mixing up the terms
could significantly increase the cost of capital raised, companies must
be sure to understand the two metrics and agree with investors to the
metric that raises them the capital at the appropriate price.
About the author:
GT Business
Plans has developed over 200 business plans for clients that
have collectively raised over $750 million in financing, launched
numerous new product and service lines and gained competitive advantage
and market share. GT Business Plans is the sister site of GT Venture Capital
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