Post-Money Valuation

If you’re in the process of raising capital and negotiating term sheets, you’ve likely had discussions on the use of post money / pre money valuation. Why? Because the valuation method used can have a significant impact on the equity investors receive and the dilution you incur. In this guide, we cover the basics: what, why, and how post money valuation is used, as well as the benefits and drawbacks of using post money valuation when raising capital.

What is post money valuation?

A post money valuation is a dollar figure that describes what a company is worth following a capital injection in the business. When negotiating term sheets, a company’s post money valuation is used by all the major types of investors including individual investors, angels, angel syndicates, angel groups, and venture capitalists.

How to calculate post money valuation?

To calculate the post money valuation of your startup, take the initial investment provided by your investors ($), divided by the percentage of ownership that your investor will receive.

For example, let's say company z is raising $5M for 20% of the business. The post money valuation of company z is $25 million = $5M / 20%.

If you are issuing new shares as part of your raise, the calculation is slightly different. Take the amount that you’re receiving ($) multiplied by the result of: total outstanding shares divided by the number of new shares you issued.

For example, let’s say the same company is raising the same $5M and has 100k shares outstanding, but is now issuing 20k new shares as part of the raise. The post money valuation of the company is $30M, or $5M * (120,000/20,000).

How can you determine your ballpark valuation?

If you’re a pre revenue or early-stage startup, determining your ballpark valuation is fairly straightforward, but comes with a large margin of error. Consider using one of the following:

• Comparable entrants. One of the easiest ways to determine how much your company is worth is to look at the other startups that recently entered the market in your space and raised capital.
• Mature businesses. In most categories, there is a legacy market leader with publicly available information on valuation, revenue, price to earnings…etc. Consider benchmarking your valuation on a highly discounted multiple of their information. 
• Market size. This is the least accurate of the three. Leverage industry databases to understand how big the total market is, how big the addressable market is and how big your obtainable market is.

Post money vs pre money valuation?

Post money valuation refers to the value of the company after it receives capital, whereas pre-money valuation refers to the value of the company before it receives capital. By leveraging the post money valuation, the investor receives a higher equity position, and the founding team and current investors incur more dilution.

To demonstrate just how different the outcomes would be, let’s look at an example. Let’s say your company is worth $100M and you’re raising an additional $20M.

Post money dilution = $20M/$100M = 20% 
Pre money dilution = $20M / ($100M + $20M) = 16.66%

Using the post money valuation, your company is worth $100M, you receive $20M and in exchange, your investors receive 20% of your company. However, if you were raising the same $20M using pre money valuation, you would only have to give up 16.66%.

The 3.33% difference might not sound like a lot, but let's say your company goes public at a $1B valuation. Assuming no other investors, using the post money valuation you’d receive $800M, using the pre money valuation you’d receive $833.33M—a difference of nearly $35M.

Use of post money valuation in venture capital?

Post-money valuation is typically used for pre revenue or early-stage startups without a proven track record. This is because venture capitalists need to generate 50-100x returns on their capital, and to protect their downside risk they need to maximize their upside potential on all deals. As such, VCs will push for post money valuation wherever possible.  If you are presented with a term sheet that uses post money valuation, strongly consider pushing for the use of pre money valuation.

What is the use of post money valuation in up rounds, flat rounds, and down rounds?

Post-money valuation can technically be used in up, flat and down rounds alike. However, it is most often used in flat or down rounds where investors have more leverage.

What other terms can post money valuation affect?

The post money valuation of a startup affects all the same terms and provisions as its pre-money valuation including the most favored nations clause, pro rata rights, participation rights, and anti-dilution protection.

How does post money valuation impact the financing overall?

Post money valuation impacts a startup's financing options in the same ways that pre money valuation does. It can impact the quality and quantity of investors that a startup can attract, it can impact the amount of capital that a startup can raise, it can impact contractual provisions, and it can impact the valuation of the startup in subsequent financing rounds.

What are the benefits of using post money valuation?

• More Attractive to investors. Post money valuation is more attractive to investors than pre money valuation because they receive more equity for every dollar invested.
• Useful in sticky situations. If you’re struggling to raise capital or raising in a down round, you can use post money valuation to make the opportunity more attractive.
• Leverageable. If you are presented with a term sheet filled with provisions, like anti-dilution protection, liquidation multipliers, or liquidation preferences consider using your post-money valuation to reduce the provisions.

What are the drawbacks of using pre money valuation?

• Higher dilution. As shown in the example above, using post money valuation results in more dilution to the founders and former investors in the company. 
  It can trigger other provisions. Using both pre and post-valuation may trigger the most favored nations clause, pro rata rights, participation rights, and anti-dilution protection among other things.

Common pitfalls to avoid when using post money valuation? 

Using post money valuation when raising capital is significantly more costly than using pre money valuation. As such, the major pitfall you should avoid is stacking post money valuation with other contractual provisions. If you are forced to use post money valuation, consider negotiating to remove one or more of the provisions to minimize your cost of capital.