Banking and Finance

Banking and Finance  » Pre-Money vs. Post-Money Valuation

Pre-Money vs. Post-Money Valuation

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

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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.