Venture Capital Funding Startup Guide
pre-money, post-money, valuation, calculation, venture capital investment
What is pre-money valuation and post-money valuation?
The pre-money valuation of a company refers to the valuation of the company before an investor injects capital into the company. The post-money valuation of a company refers to the valuation of the company after an investor has injected capital into the company. Therefore, the post-money valuation of a company is always equal to the pre-money valuation plus the amount of capital injected by the investor. Both pre-money valuation and post-money valuation are expressed in terms of dollars.
What is the significance of pre-money valuation and post-money valuation?
Valuation is critical to both the investor and company in a private equity/venture capital (pe/vc) financing. Before an investor invests in a company, the investor will almost always first do a valuation of the company. In a financing transaction (e.g., a Series A round), investors inject capital into a company in return for Series A shares. The pre-money valuation of the company determines how much equity (or the percentage ownership) an investor gets in return for the capital which it injects into the company in that financing.
Pre-money valuation and post-money valuation equations:
(The below equations are for discussion purposes only. You do not need to memorize them. Once you understand the concept of pre- and post-money valuation, everything becomes simple maths and should make sense on its own.)
1. Post-money valuation = Pre-money valuation + Investment amount
2. Purchase price per share = Pre-money valuation / Number of fully-diluted shares before investment
3. Number of new shares issued to investor = Investment amount / Purchase price per share
4. Number of fully-diluted shares after investment = Number of fully-diluted shares before investment + Number of new shares issued to investor
Venture Tech Ltd. currently has 4,000,000 common shares held by its founders, being 100% equity of the company.
It is agreed between Venture Tech Ltd. and Investor A that in the forthcoming Series A round, 1,000,000 common shares will be set aside for ESOP.
Therefore, the number of fully-diluted shares of Venture Tech Ltd. before the Series A round is 4,000,000 + 1,000,000 = 5,000,000.
Before financing, Investor A gives Venture Tech Ltd. a valuation of US$4,000,000.
Therefore, the pre-money valuation of Venture Tech Ltd. is US$4,000,000.
Purchase price per share:
Each share is valued at $4,000,000 / 5,000,000 = $0.8 (calculated on a fully-diluted basis).
Now, Investor A invests US$2,000,000 into Venture Tech Ltd. in a Series A financing.
Therefore, the post-money valuation of Venture Tech Ltd. will be US$(4,000,000 + 2,000,000) = US$6,000,000.
Number of new shares issued to Investor A in the Series A round:
Since each share is valued at $0.8, Investor A gets ($2,000,000/$0.8) = 2,500,000 Series A shares.
Post-financing capitalization (calculated on a fully diluted basis - i.e., including ESOP):
Percentage ownership of founders is diluted from 100% to 53.33% (4,000,000 / 7,500,000).
Percentage ownership of Investor A = 2,500,000 / 7,500,000 = 33.33%.
Percentage of ESOP in relation to the number of fully-diluted shares = 13.33%
Total: 53.33% + 33.33% + 13.33% = 100%
Post-financing capitalization (calculated not on a fully-diluted basis - i.e., excluding ESOP):
Percentage ownership of founders is diluted from 100% to 61.54% (4,000,000 / 6,500,000).
Percentage ownership of Investor A = 38.46% (2,500,000 / 6,500,000 ).
Total: 61.54% + 38.46% = 100%
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