Pre-money valuation

A pre-money valuation is a term widely used in private equity or venture capital industries, referring to the valuation of a company or asset prior to an investment or financing. If an investment adds cash to a company, the company will have different valuations before and after the investment. The pre-money valuation refers to the company's valuation before the investment.

External investors, such as venture capitalists and angel investors will use a pre-money valuation to determine how much equity to demand in return for their cash injection to an entrepreneur and his or her startup company. This is calculated on a fully diluted basis.

Usually, a company receives many rounds of financing (conventionally named Round A, Round B, Round C, etc.) rather than a big lump sum in order to decrease the risk for investors and to motivate entrepreneurs. Pre- and post-money valuation concepts apply to each round.

Basic formulae

$\text{post-money valuation} = \text{new investment} \,\cdot\, \frac {\text{total post investment shares outstanding}}{\text{shares issued for new investment}}$

$\text{pre-money valuation} = \text{post-money valuation} - \text{new investment}$

Round A

Shareholders of Widgets, Inc. own 100 shares, which is 100% of equity. If an investor makes a $10 million investment (Round A) into Widgets, Inc. in return for 20 newly issued shares, the implied post-money valuation is:

$10 million * (120 / 20) = $60 million

This implies a pre-money valuation equal to the post-money valuation minus the amount of the investment. In this case, it is:

$60 million – $10 million = $50 million

The initial shareholders dilute their ownership to 100/120 = 83.33%.

Round B

Let's assume that the same Widgets, Inc. gets the second round of financing, Round B. A new investor agrees to make a $20 million investment for 30 newly issued shares. If you follow the example above, it has 120 shares outstanding. Post-money valuation is:

$20 million * (150 / 30) = $100 million

The pre-money valuation is:

$100 million – $20 million = $80 million

The initial shareholders further dilute their ownership to 100/150 = 66.67%.

Upround and downround

Upround and downround are two terms associated with pre- and post-money valuations. If pre-money valuation of the upcoming round is higher than the post-money valuation of the last round, the investment is called an upround. If the reverse is the case, then the investment is called a downround. In the above example, Round B was an upround investment, for pre-money B ($80 million) was higher than was post-money A ($60 million).

A successful company usually has a series of uprounds until it is IPO-ed, sold, or merged. Downrounds are painful events for initial shareholders and founders, for they cause substantial ownership dilution and may damage the company's reputation. However, downrounds were common during the dot-com crash of 2000–2001.

See also

• Post-money valuation
• Capitalization table

External links

• Forbes Investopedia: What's the difference between pre-money and post-money?
• Ryan Roberts: What is a Pre-money and Post-money Valuation?
• Samuel Wu: Venture Capital 101 for Startups — Valuation