When your startup company raises capital, valuation is a key question that must be tackled Rey Maualuga style. (If you are unfamiliar with “Rey Maualuga style,” click here for a Youtube example.) The two main valuation concepts in a venture capital financing are pre-money and post-money valuation.
In a venture capital transaction, the venture capital firm invests cash in the startup company in exchange for newly-issued (preferred) stock. The startup company’s value immediately before the funding is called “pre-money valuation” while the startup company’s value immediately after the transaction is called “post-money valuation.” (Technically, pre-money and post-money are more about price than a startup company’s valuation.)
Pre-money Valuation and Post-money Valuation Equations
(1) Pre-money Valuation = Post-money valuation – Venture Capital Investment
(2) Post-money Valuation = Venture Capital Investment/Venture Capital Ownership Percentage
You can determine share price by the following equation:
(3) Share Price = Pre-money Valuation/Number of Pre-money shares.
You can determine how many shares to issue the venture capital firm by this equation:
(4) New Shares Issued = Venture Capital Investment/Share Price
Pre-money Valuation and Post-money Valuation Examples
Let’s say Google’s new venture fund comes to you and offers to invest $3MM into your startup for 30% of the company. Plugging the numbers into equation (2), we get:
Post-money valuation = $3MM/.30 = $10MM
Thus, to calculate pre-money valuation, we use equation (1) as we now know the post-money valuation and the investment amount:
Pre-money valuation = $10MM – $3MM = $7MM
Now let’s say a venture capital firm offers your startup company a $4MM investment at a $6MM pre-money. To determine how much your startup would give up in exchange for the $4MM, we use equation (1) and get:
$6MM = Post-money valuation – $4MM, and solving for Post-money valuation (Post-money = Pre-money + Investment) gives us $10MM
Next, we use equation (2) to find the Venture Capital firm’s percentage:
$10MM = $4MM/Venture Capital Firm Ownership Percentage (VCFOP), solving for VCFOP (VCFOP = $4MM/$10MM) we get 40%.