Pre-Money Valuation Explained

Raising investment for your company can be a long process to navigate, from perfecting your pitch to knowing how much equity to offer in exchange for investment capital. Your pre-money valuation will help you with the latter: the metric generally forms what an investor’s share will be based on how much capital they put into the company. It will be the basis of investment negotiations, so let’s explain what just what pre-money valuation means.

What is a pre-money valuation?

A pre-money valuation is the estimated value of a company before it receives outside investment, whether that’s new capital from investors or external funding. Essentially, it is the overall valuation of the company at its current state. It helps investors decide if your company has lucrative potential and gives them an understanding of what their return on investment could be.

A pre-money valuation is determined before each round of funding. If all goes well, it will increase over time.

It’s important not to exaggerate your pre-money valuation. It raises expectations high for investors, and if you don’t deliver, you might have to lower your valuation for the next round. Not only does this negatively impact current investors, but it also sends a bad impression to potential future investors. It should be a realistic assessment of your company’s value to build trust with your investors and develop a fair deal that benefits both parties.

How does pre-money valuation determine shares/equity?

The pre-money valuation is a key metric used by investors to determine what shares they could take in the business. The equity or shares an investor gets will be proportional to the overall valuation.

For example:

• If Company A has a pre-money valuation of £1,000,000 and Investor A puts £250,000 into the business, Investor A will own 20% of the company.
• £250,000 / £1,250,000 = 20%.
• This calculation is a general rule of thumb and one that can be negotiated.

Founders generally want their company to have a high pre-money valuation, so they can sell shares for a higher buy-in. However, investors will find companies with a lower valuation more cost-effective as they can buy more shares for less. There must be a mutually beneficial deal between the founder and the investor, which is where the negotiations help to strike that balance.

How are pre-money valuations calculated?

There is no exact rule to calculate pre-money valuations. Most early-stage companies will have few financial indicators to base their valuation on. Some might not even have a product to put on the market yet. So, it’s often an estimated value that’s agreed upon between the founder and the investor. However, there are some key metrics and factors that influence a pre-money valuation. They are as follows:

Interest in the deal: If several investors want in on the deal, then it’s a good indicator of a high pre-money valuation. In this situation, the founders have the upper hand and can use this to increase the company’s valuation. If there isn’t much interest in the deal, then the investors can leverage a lower valuation and higher ownership.

The strength of the team: If there are few financials to go by, investors place a lot of stock in the founders and their team. Investors will carefully assess the overall team’s skill set, experience, and track record.

The market potential: Is your product or service a part of a highly saturated, stagnant market? Or is there a good potential for growth? Investors will evaluate how your product/service fits into its target market, and if there is substantial and sustainable growth potential.

Compare with similar businesses: With little to go off, investors often compare startups to similar companies further along the journey. They’ll use the more established companies’ market value and revenue to gauge potential.

Traction: While it’s harder to gauge traction in the early stages of a business, it’s a great metric for determining a pre-money valuation. If possible, present your existing customer base, mailing list, revenue, or user engagement to showcase your company’s potential value.

What is the difference between pre-money valuation and post-money valuation?

While pre-money valuations and post-money valuations are crucial for founders and investors to understand how much a business is worth, the key difference is timing. Pre-money valuation refers to how much a company is worth without investment, while post-money valuation includes external funding. It’s important to specify which type of valuation you are referring to when discussing this with investors to portray an accurate depiction of the company’s financial position. If you get these mixed up when discussing your valuation, then you could be giving away a lot more equity than you realise.

Company A pre-money valuation: £1,000,000

Investor A: Invests £250,000

Company A post-money valuation: £1,250,000

Pre-revenue valuation is another important distinction. While it’s not as commonly discussed as pre-money valuation, it does sometimes come up. A pre-revenue valuation is how much your company is worth before it has made any revenue from your products or services.

Agreeing on a fair pre-money valuation is an important discussion point between the founder and the investor. The negotiation process is key – as a founder, you might end up giving away a large portion of your company if the pre-money valuation is lower than it should be. Get in touch with the financial experts at Finerva to discuss early-stage investments.