Venture capital financing for businesses can be a complex matter. One of the key aspects to successful venture capital financing is accurate valuation of the company at hand. This often is part of the tricky negotiation process between a company’s owners and potential investors. Specifically, this is broken down into pre-money valuation and post-money valuations.
Because of this, it is usually recommended to work with an attorney specializing in venture capital, mergers and acquisitions and business contracts in order to ensure a company’s best interests are protected at every stage of the financing. The figures determined during the pre money valuation and post money valuation are important for startups, having a large impact on the ultimate success of the financing round, especially for emerging companies where capital is vital.
Pre-Money Valuation vs. Post-Money Valuation
The difference between a pre-money valuation and a post-money valuation of a company ultimately comes down to timing. Basically, the pre-money valuation of a company refers to its agreed-upon worth before the next round of financing has occurred. Post-money valuation simply refers to its value immediately after receiving the capital financing.
Why These Differences Matter
The difference between pre and post money valuations are important because it ultimately determines the equity share that investors are entitled to after the financing round has concluded. As an example, if a company were to receive $250,000 in capital, the investors would have a 20% equity share if the pre-money valuation was determined to be $1 million. However, if the pre-money valuation were instead to be set at $750,000 the percentage would then jump to 25%. This is a significant difference that can have lasting legal and financial consequences on all parties involved long after the financing round has concluded.
Formulas Used for Post-Money Valuation
Determining post money valuation is a straightforward task, with two standard ways to accomplish it. The first method is to add the value of the investment to the pre-money valuation of the company. The second method is by dividing the new investment amount by the quantity of shares received, then multiplying that per share valuation by the total number of shares issued post-investment.
The challenging part of this however is determining the pre-money valuation of a company. This is a negotiated value that depends on a combination of investor-driven formulas and metrics instead of just simple math. Sometimes disagreements will arise about the methodologies used to arrive at the pre-money valuation of the company, which can cause heated negotiations.
Typically, the parties consider a number of factors when determining pre-money valuation of a company. These factors can include recent comparable offerings made by other investors, exit value calculations, and historical cash-flow for the company as well as its performance. Additionally, when this involves pre-revenue companies it makes this valuation even more challenging as it is often hotly contested. It is exceptionally difficult to determine the pre-money validation of a startup company due to the lack of a concrete performance track record.
Hiring A Venture Capital Attorney
Valuation of a company is one of the most challenging aspects of venture capital financing. In these cases, it is vital that both investors and business owners consult with legal experts to ensure that they are getting the fairest deal possible. Oftentimes large investment companies and individual investors will have legal staff at their disposal to ensure their best interests are being taken into consideration. However, most companies seeking investors do not have this capability, especially smaller businesses and startups.
The business law experts at Hoeg Law are highly regarded in the legal community, with years of experience handling venture capital funding scenarios. If your company is in need of assistance handling pre-money or post-money valuations or both, please contact our office today to discuss how we can help you achieve your business goals.