Pre-Money versus Post-Money: What Valuation Cap is Best for You?

START & GROW YOUR BUSINESS

October 12, 2020

Josephine Bulat

Determining how to measure a company’s valuation is an essential beginning step, both from the perspective of an investor and a start-up.

Valuation of the Company

It’s easier to begin with calculating the Post-Money valuation. Input the amount an investor is willing to give, and divide it by the ownership percentage they are seeking with such an amount.  

POST-MONEY VALUE = Investment Amount ÷ Ownership Percentage Investor Receives

Let’s imagine an investor is willing to give $1 million for 10% of the company. The calculation would look like this:  

$1,000,000 ÷ 10% = $10,000,000.

The Post-Money valuation is therefore $10 million. However, this is not the value of the company today; this is the valuation once an additional $1 million is added to the company’s value.  

To calculate the Pre-Money valuation, and thus what the company is valued at today before receiving additional investments, you must take the Post-Money valuation and then subtract the investment amount.  

PRE-MONEY VALUE = Post-Money Valuation – Investment Amount

So using the values from the example above, the calculation would look like this:  

$10,000,000 - $1,000,000 = $9,000,000.

Once you know the Pre-Money valuation, you are able to calculate the current value per share of the company by dividing the Pre-Money valuation by the number of outstanding shares.

CURRENT PRICE/SHARE = Pre-Money Valuation ÷ Number of Outstanding Shares

Valuation Caps

Valuation Caps (VCs) place a limit on the price at which convertible debt will become equity. It will be converted at the lower of A) the valuation cap, or B) the pre-money valuation set in the current funding round.  

If the valuation exceeds the cap, debt is converted as if the valuation were at the cap. If the valuation is less than the cap, the debt is converted at the current valuation.  

Let’s look at a few scenarios:

Scenario 1: NO Valuation Cap

Pre-Money Valuation = $10 million

Pre-Money VC = $0 (no VC)

Investment amount (Safe round) = $1 million

Series A round of investment (first significant round of venture capital) = $5 million

Prior to the Series A financing, the company had 10 million outstanding shares

Using our Share Price formula above, we can calculate the following:

CURRENT PRICE/SHARE = Pre-Money Valuation ÷ Number of Outstanding Shares

CURRENT PRICE/SHARE = $10 million ÷ 10 million shares

           = $1.00 per share

So if a $1 million investment was made by the investor, they receive 1 million shares ($1million ÷ $1.00 per share). This means an additional 1 million shares were added to the original 10 million (so now 11 million).  

Now take a look at the Series A investor: if the price per share is $1.00, and he/she invested $5 million, then they own 5 million shares. This also means the company now has 16 million total shares.

Scenario 2: $5m PRE-MONEY Valuation Cap

Pre-Money Valuation = $10 million

Pre-Money VC = $5 million

Investment amount (Safe round) = $1 million

Series A round of investment (first significant round of venture capital) = $5 million

Prior to the Series A financing, the company had 10 million outstanding shares

With a PRE-MONEY VC, you can calculate the conversion price per share:

PRE-MONEY CONVERSION SHARE PRICE = Valuation Cap ÷ Number of Outstanding Shares

So in this scenario, our calculation would look like this:

PRE-MONEY CONVERSION SHARE PRICE = $5 million ÷ 10 million shares

        = $0.50 per share

As stated above, the convertible debt will be converted at the lower of A) the valuation cap, or B) the pre-money valuation set in the current funding round.  In this scenario, (A) is lower so the debt is converted to company equity at $0.50. So now the investor receives 2 million shares in the company and thus a larger ownership percentage.

Valuation Cap in Safe

This is why we recommend Safe investors use a pre-money valuation cap – their ownership may increase. If the valuation cap is lower than the actual valuation of the company at the next funding round, the investor will receive a greater proportion of equity.  

On the same note, this is why we recommend company founders use a post-money valuation cap – pre-money VCs can dilute their ownership percentages by a greater amount. Post-money caps also allow companies to immediately calculate how much ownership has been sold.  

By “post-money,” we mean that the valuation is calculated and Safe holder ownership is measured after all the money invested in the Safe round is accounted for but still before the new money in the priced round that converts and dilutes the Safes (usually the Series A, but sometimes Series Seed).

Here is a calculator to help you input various amounts and determine which cap works best for your company and your investments.

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