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Pre-Money vs. Post-Money: What’s the Difference?

What’s the difference between pre-money and post-money? The timing of the valuation is the answer to this question. Both pre-money and post-money are valuation measures of companies and are critical in determining how much a company’s worth, especially with start-ups and early-stage companies.

Pre-Money

Pre-money valuation is the value of a company excluding external funding or the latest round of funding / investment. Pre-money is best described as how much a business might be worth before it begins to receive any funding. This valuation gives investors an idea of the current value of the business, but it also calculates the value of each issued share.

Post-Money

Alternatively, post-money refers to how much the company is worth after it receives the cash investments into it. Post-money valuation includes outside financing or the latest capital injection. Therefore, it is important to differentiate between the two as they are critical concepts in the valuation of any company.

Here’s an example which helps explain the difference:

Suppose an investor is looking to invest in a tech startup. The founder and the investor both agree that the company is worth $2 million, and the investor will put in $500,000.

The ownership % of the founder and the investor will depend on whether this is a $2 million pre-money or post-money valuation. If the $2 million valuation is pre-money, the company is valued at $2 million before the investment.  After the investment, the company is valued at $2.5 million. Therefore, if the $2 million valuation takes into consideration the $500,000 investment, it is referred to as post-money.

 

Pre-Money Valuation Post-Money Valuation
 Value % Ownership  Value % Ownership
Founder $2,000,000 80% Founder $1,500,000 75%
Investor $500,000 20% Investor $500,000 25%
Total $2,500,000 100% Total $2,000,000 100%

 

As you can see, the valuation method used can have a big impact on the ownership percentages. This is due to the amount of value being placed on the company before investing. So, if a company is valued at $2 million, it is worth more if the valuation is pre-money because the pre-money valuation does not include the $500,000 invested. While this ends up affecting the founder’s ownership by a small percentage of 5 percent, it can potentially represent millions of dollars if the company goes to IPS / exits.

In many cases, it’s very hard to determine what the company is really worth. Valuation becomes a subject of negotiation between the founder and the investor, especially with start-ups and early stage companies.

Calculating Post-Money Valuation

Calculating the post-money valuation is easy. Simply use this formula:

  • Post-money valuation = Investment dollar amount ÷ percent investor receives

So if an investment is worth $2 million nets an investor 20%, the post-money valuation would be $10 million:

  • $2 million ÷ 20% = $10 million

Bear one thing in mind. This doesn’t mean the company is valued at $10 million before getting a $2 million investment. This is due to the balance sheet showing only shows an increase of $2 million worth of cash, increasing its value by that same amount.

Calculating Pre-Money Valuation

The pre-money valuation of a company comes before it receives any funding. This figure does give investors an indication of what the company would be valued at today. Calculating the pre-money valuation is also easy. But it does require one extra step—and that’s only after you figure out the post-money valuation. Simply:

  • Pre-money valuation = Post-money valuation – investment amount

Using the example from above to demonstrate the pre-money valuation. In this case, the pre-money valuation is $8 million. That’s because we subtract the investment amount from the post-money valuation. Using the formula above we calculate it as:

  • $10 million – $2 million = $8 million

With this knowledge, the pre-money valuation of a company makes it easier to determine its value per individual share. This can be calculated as follows:

  • Per-share value  = Pre-money valuation ÷ total number of outstanding shares

 

Article written by Peter O’Sullivan, Regional Director at The CFO Centre

Growing a Business

A client recently said to me: “I want to grow our business and stop the cash burn – how do we do this? When is it the right time to invest and grow?”

What a tough question to answer. Each business is at a different stage.

We spent a day examining his business and determining what the growing pains were. He had started the business a few years ago and it grew from scratch to $750k turnover last financial year. This year they may potentially reach a turnover of $1.2m.

It was generating a great turnover and growing but they never had any cash.

“Why?” he asked.

After reviewing the business financials it was quite clear that the internal systems were not in place. He could not possibly understand the profitability of the products they were selling due to these inadequate systems.

Therefore they could not take the next step.

The first question I asked was: “Where do you want to take this business – what’s your goal? To build up the business and exit down the line, or are you looking to exit now? Or is this business a keeper if we can generate a great RoI?”

The response was: “We don’t know the numbers or where this business could get too as we have no clarity on the numbers”.

Something I see very commonly here in the SME businesses I work with – no clarity around the financials.

Next Steps

Step one for this particular client was to build a reporting framework around their products to determine what was profitable and what as not. If there were non profitable products (or those that deliver little profitability), should we dump them or only include them bundles in the online offering?

Step two: Build a fully flexible 3-way financial model (P&L, Cash Flow and Balance Sheet) for the next 3 years. Play around with the assumptions, i.e what other products can we put into the offering to customers?

Step three: Monthly reviews against the plan – what worked, what didn’t work and the whys around both.

The right time for a business to grow is when they can balance new customer demand with their internal systems and processes. Moreover, in the instance of this client, increasing recurring revenue streams. Growing faster generally costs more per customer as they need to engage more expensive channels within the business model.

Scalability is about continuing to engage customers with new offerings, and to engage new customers with your offering to the market.

To scale a business one must consider how the business model will affect the bottom line when you expand operations. If you have low capital expenditure and can grow your business with the same revenue / expense % it is much easier to deliver greater numbers in the long term and provide greater options to your customers.

It is early days working with this client but the potential is endless.

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