Post-money valuation is an essential tool that investors use to determine their percentage of equity in your company. The post-money valuation is also a key indicator of your startup’s performance.
In this article, we will detail the meaning of post and pre-money valuation, its importance to founders, and its implications for your startup.
Let’s dig in.
What does post-money valuation mean?
In a startup, the post-money valuation equals the sum of the pre-money valuation and additional external investments your startup receives in a financing round. Your startup can receive capital from investors through convertible notes or simple agreements for future equity (SAFEs).
To investors, the post-money valuation can indicate your startup’s performance and potential. The higher the valuation, the more appealing the startup will be. Negative performance, or a lower valuation, can harm your reputation but is not the end all be all.
To measure your startup’s performance, investors will use your post-money valuation from the previous financing round as a reference point. The increase/decrease of your valuation is labeled as an “up-round” or “down-round,” respectively.
For startup leaders, an “up-round” is a sign of growth that attracts investors. Demonstrating the return on investment your startup offers can help you make more successful negotiations.
Calculating post-money valuation can be challenging, but it is crucial for measuring your startup's growth and value. The post-money valuation is insightful for investors and can guide your operational and financial decisions.
Let's start at the beginning to understand post-money valuation and its implications thoroughly. Your startup’s pre-money valuation is equally as important.
What is pre-money valuation?
The pre-money valuation of your startup is another vital tool for negotiations with investors. You should know your pre-money valuation before raising capital in a financing round.
For founders, the pre-money valuation is essential to “sell” the potential value of your startup. If your startup is fresh, you will not have much past data to represent your value, and the pre-money valuation can be challenging to determine. Instead of past numbers, you must use the potential capital value of your assets.
Your assets can include your knowledge and experience, that of your employees, and any capital other investors have promised you. Investors will be more likely to give you funding if they know others are interested. Your industry’s competitors and target market will also determine your pre-money valuation.
When negotiating, your pre-money valuation will tell investors how much capital you want to raise. For example, if you want to raise $1 million with a $3 million post-money valuation, your pre-money valuation is $2 million. This indicates how much equity an investor would own in your startup if they invest. In this example, their equity is 33% or one-third.
How to calculate post-money valuation?
You can calculate your post-money valuation by adding any new capital you earned in a financing round to your pre-money valuation.
If you have a pre-money valuation of $2 million and in one round of financing, you receive $500,000, the post-money valuation is the sum of these two numbers. $2 million plus $500,000 is $2.5 million, which will be your post-money valuation.
With the pre-money valuation, you can calculate your post-money valuation after completing a financing round and totaling the capital you received. After adding new shares to your startup, you should adjust your rice per share calculation for dilution. You can do so by multiplying your share price before investment by your total number of shares, including the new shares.
What are up-rounds and down-rounds?
Your pre-money and post-money valuations indicate your startup’s performance from the previous financing round. The terms used to indicate your startup’s performance are up-rounds and down-rounds.
An “up-round” is when your post-money valuation increases from a previous financing round. It is a positive performance indicator. With growing capital, your startup is more likely to attract new investors and raise more money.
A “down-round” is a lower-post money valuation compared to a previous round of financing. A down-round can negatively affect your startup’s image and appeal to investors. This can indicate that your startup is losing capital and cannot produce a return on investments (ROI).
However, a down-round does not mean the end of the world. In some cases, after suffering losses between two financing rounds, the capital you receive will give you the means to return to positive ROI.
Why is post-money valuation important?
The post-money valuation of your startup is a sound performance indicator and determines the equity percentage for investors. The number is essential for your startup to appeal to investors and raise capital.
As we mentioned before, the increase or decrease of your post-money valuation can indicate your startup’s growth or decline. You must be careful when presenting your valuation to investors. If you keep close records of your startup’s finances, you can confidently present your valuation and estimates and raise more capital.
The negotiations between founders and investors will determine what percentage of your startup the investor will buy. As a founder(s), you are your startup's main shareholder and should carefully consider your desired equity during any investment deals.
Any capital you receive from an investor can be taken as a percentage of your startup’s post-money valuation to determine the amount of equity they own. For example, if you have a post-money valuation of $1 million after receiving an investment of $250,000, the investor has a 25% equity stake in your startup.
Negotiation tools for founders
Your pre and post-money valuations will determine an investor’s future equity and the amount they look to invest. There are other important figures you must consider and include in your deals with investors.
Post-money valuation option pool
An employee option pool is a group of your startup’s shares that are reserved for employees only. An option pool prevents too large a percentage of your startup’s equity from being given to investors.
As the option pool affects an investor’s potential equity, they are also an important talking point in negotiations.
Post-money valuation cap
A post-money valuation cap is used as insurance for investors in case the valuations decrease in later financial rounds. The cap serves to limit the price investors can use when converting any SAFEs to new shares from your startup.
The cap is another important number in negotiations. The higher the cap you set, the higher the equity value that an investor will receive in shares after conversion.
Post-money valuation: Key takeaways
- To recap, post-money valuation is the value assigned to a startup that includes any external funding the startup received during the latest round of financing.
- To get your post-money valuation, you need to add any investments or capital you have raised to your balance sheet, and the sum of your pre-money evaluation and the new capital is your post-money valuation.
- A post-money valuation is an important metric for you and potential investors. The post-money valuation determines the ownership stake you and investors can claim. It is also a crucial performance indicator that can accelerate or halt your startup's growth.
- Calculate the value of your current assets, observe your competition, and scale your target market to create a pre-money valuation. This will determine an investor's potential equity stake in your startup, and further influence their decision to invest.
- Given the diverse collection methods startups use, and anti-dilution precautions investors take, determining your pre and post-money valuation will take time. However, given the significant implications, we recommend taking the steps necessary to measure and evaluate your startup properly.
Disclaimer: LTSE is neither a law firm nor provides legal advice. Before making decisions on matters covered by this post, readers should consult their legal adviser.