Pre-Money Valuation

Publication Date :

13 Sep, 2022

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Table Of Contents

What Is Pre-Money Valuation?

The pre-money valuation assesses a company's equity value before raising funds via IPOs, external debts, or financing. Venture capitalists, investors, and financiers make investment decisions based on these projections.

The valuation also hints at potential risks associated with a particular start-up. Pre-money figures indicate a specific percentage of corporate shares to be demanded in exchange for the investment. Pre-money figures are hypothetical numbers—it is derived using projections of post-money valuations.

What Is Pre-Money Valuation?

The pre-money valuation is the initial evaluation of a company's equity or worth before the commencement of any funding or investment round through public issues, external debt, or financing.
Initially, most owners use personal capital to fund their start-ups. This is known as bootstrapping stage. Investors prefer valuation to identify a firm’s credibility and associated risks at this stage.
Pre-money is the opposite of the post-money assessment, which focuses on the company's equity value after a successful round of funding. It is computed as the difference between the firm's post-money valuation and the investment amount:
'Pre Money Valuation = Post Money Valuation - Investment Amount.'

Pre-Money Valuation Explained

Initially, most owners use personal capital to fund their start-ups. This is known as bootstrapping stage. Thus, pre-money valuation meaning determines a company’s real worth before receiving any form of external financial leverage—public investment or private funding.

Most valuations occur at the seed funding stage of business. Before raising external funds, 100% of ownership (equity) lies with the company founders. Hence, investors need an early-stage evaluation to determine a target’s pre-revenue value before investing. In addition, it gives investors an overview of the targets’ credibility and risk. Moreover, this data is used by investors to negotiate the final equity and investment amount.

However, pre-money valuations are hypothetical figures—it is derived using the projections of post-money valuation. Moreover, one needs to be cautious before investing in any company based on its pre-money number since it may not always be as genuine as it appears.

Entrepreneurs deliver convincing pitches and claim that their business is revolutionary—with sky-high profit projections. But investors must undertake thorough due diligence before parting with any sum. In addition to pre-money figures, they must review the target firm's business model, book of accounts, and plans. Investors must always run a thorough background check on founders and entrepreneurs.

Formula

The pre-money valuation formula is expressed as follows:

Pre-Money Valuation=Post Money Valuation-Investment Amount

In contrast, Post-Money Valuation is the expected equity value after completing funding rounds. Post Money Valuation is computed as follows:

Here, Investment Amount = Value Per Share × Investment Size
Investment Size = Original Shares Outstanding + New Shares Issued

Calculation Examples

Following are some examples of pre-money valuations.

Example #1

ABC Ltd. has been offered an investment of $25000 instead of 20% equity ownership. Now, based on given values, determine the pre-money valuation.

Solution:
Post Money Valuation = Investment Amount / % Equity Ownership

Post Money Valuation = $25000 / 20% = $125000

Also,
Pre Money Valuation = Post Money Valuation – Investment Amount

Pre Money Valuation = $125000 - $25000 = $100000

Thus, the pre-money valuation of ABC Ltd. is $100000.

Example #2

XYZ Ltd plans to issue 36000 shares at $11 per share. First, the firm liquidates 18% of its equity. Now, based on given values, evaluate the company's pre-money valuation.

Solution:
Investment Amount = Value Per Share × Investment Size

Investment Amount = $11 × 36000 = $396000

Post Money Valuation = Investment Amount / % Equity Ownership

Post Money Valuation = $396000 / 22% = $1800000

Also,

Pre Money Valuation = Post Money Valuation – Investment Amount

Pre Money Valuation = $1800000 - $396000 = $1404000

Thus, the pre-money valuation of XYZ Ltd. is $1404000.

Pre-Money vs Post-Money Valuation

Both pre-money and post-money figures serve as crucial decision-making parameters. Investors analyze a target firm’s performance based on the business' equity value. Given below are the prominent differences between the two:

Basis	Pre-Money Valuation	Post-Money Valuation
Meaning	It is the value of a company's equity before it raises any money from external or private sources.	It is the company's worth or equity value after a round of funding from external sources.
Timing of Valuation	It is done before rounds.	It is commonly performed after seed funding rounds.
Equity Ownership	Founders own 100% of their firm’s equity.	A certain portion of the firm's equity belongs to the investors.
Purpose	Investors use pre-money figures to negotiate the investment amount.	It gauges the equity share of investors at the end of funding rounds.
Formula	Pre-Money Valuation = Post Money Valuation – Investment Amount	Post-Money Valuation = Investment Amount / % Equity Ownership
Ease of Calculation	It is comparatively difficult to evaluate. It requires the estimation of the post-money valuation.	It is easy to evaluate. The investment amount and equity ownership shares are known.
Accuracy of Result	It provides an estimate or hypothetical figure. Post-money valuations are mere projections. They are not precise.	Since it is done after funding rounds, the results are accurate and provide a real numeric value.

Frequently Asked Questions (FAQs)

1. What is the difference between pre-money valuation and post-money valuation?

The pre-money figure is a firm's equity assessment before receiving public funding, external financing, or investment. However, a post-money valuation, as the name suggests, is the determination of a company's worth or equity value after the commencement of a funding round.

2. How to calculate pre-money valuation?

The pre-money valuation is computed as the difference between the post-money valuation and the investment amount. It is mathematically expressed as:
'Pre-Money Valuation = Post-Money Valuation – Investment Amount.'

3. Why is pre-money valuation important?

Investors, financiers, and venture capitalists look for pre-money figures before betting on a start-up. It helps them gauge the current worth of a company's equity. It also hints at risks associated with a particular project. Based on these projections, investors decide upon a specific percentage to be asked instead of the decided investment amount.