Pre-money valuation explained

Your company’s pre-money valuation is important to understand how much equity you’ll offer in exchange for the investment you receive.

In this article, we’ll explain what a pre-money valuation is and highlight the key factors that influence it.

What is pre-money valuation?

Pre-money valuation is the worth of a company before it receives external funding or investments. It’s used by investors to determine how much ownership they’ll receive in exchange for their money.

Why should I care about my valuation?

Your company’s valuation is a measure of how much it’s worth. It’s one factor that helps investors decide whether or not to invest in your company.

The valuation also helps you understand, as a founder, how your ownership stake will be affected by the investment.

Let’s say an investor is putting $50,000 into your company and will receive stock in exchange.

For the investor, a lower valuation is better for them as they’d be able to buy more stock (and therefore a larger percentage of the company) for the $50,000. On the other hand, as a founder you want to be able to sell less equity for more money – which you could do with a higher valuation.

The table below shows how this $50,000 investment would look in two different valuation scenarios. Where the company’s valuation is higher, you can receive the same amount of money but offer a smaller piece of your company.

To calculate the price per share of your round, divide your company’s pre-money valuation by the total number of shares before the investment (we’ve assumed 100,000 shares here).

But, as a founder, you also don’t want an overly inflated valuation of your startup. With a big valuation, you could raise investors’ expectations – and if you don’t deliver on that, you might have to drop your valuation at your next round. This is a problem for a few reasons – the main one being that a drop in valuation can signal to investors that your company might be struggling, hurting investor confidence. Plus, if your valuation falls in the next round (called a ‘down round’), you might need to issue more stock to raise the same amount of money, which would lead to more dilution for your existing stockholders.

Pre-money valuation vs post-money valuation

Pre-money valuation is the worth of a company before it receives external funding or investments. And post-money valuation refers to how much your company will be worth after an investment.

Let’s run through an example.

UnicornTech has a valuation of $1 million before they’ve received any investment – so, this is its pre-money valuation.

It then receives $500,000 equity investment from an investor. The value of the company is now $1.5 million – which is the post-money valuation ($1 million pre-money valuation + $500,000 investment).

Companies and investors also prefer using post-money valuations because it makes it easier to calculate the share of a company that investors will receive. In the example above, a $500,000 investment at a $1,500,000 post-money valuation means investors will be left with 33.3% of the company.

When you’re negotiating an investment deal, you and your investors must be clear on whether you’re talking about pre-money valuation or post-money valuation in your term sheet.

Pre-money valuation vs pre-revenue valuation

Pre-revenue valuation is different from pre-money valuation.

Pre-revenue valuation is the worth of your company before the company has made any money (or ‘revenue’) from its products or services.

Factors that influence pre-money valuation

So what are the factors that influence the value of your company?

Determining a valuation is definitely more art than science, but here are some things that affect your valuation:

• Market potential: How big your target market is and how fast it’s growing
• Revenue projections: How much money your company is expected to make over time
• Team strength: The experience and track record of your founding team
• Product differentiation: How unique and competitive your product or service is
• Traction: The current customer base, revenue, or user engagement
• Industry trends: What’s happening in your industry and how it affects your business

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