What is post-money valuation for startups?
Valuations are one of those parts of startups that many entrepreneurs and founders only wake up to once they head out fundraising, or begin negotiations to sell their companies. That’s not ideal and certainly leaves you scrambling to catch up when you want to be out ahead of it.
Valuations for startups, in particular, are complicated further with pre-money and post-money valuations. So, what are they? How do they differ? What do you need to know about the nuances of them and their impacts on your company?
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Here is the content that we will cover in this post. Let’s get started.
- 1. What Is A Post-Money Valuation?
- 2. Pre-Money Versus Post-Money Valuations
- 3. Why Is Post-Money Valuation So Important?
- 4. The Impact Of Post-Money Valuations On Future Rounds
- 5. Access To Financing
- 6. The Value Of Your Shares
- 7. Terms Versus Valuation
- 8. Liquidation Preferences
- 9. Control
- 10. The Pros & Cons Of A High Valuation
- 11. The Pros Of High Valuations
- 12. The Cons Of High Valuations
- 13. Common Startup Valuation Methods
- 14. Achieving A Higher Valuation For Your Startup
- 15. Summary
What Is A Post-Money Valuation?
Put simply, a post-money valuation is how much your startup is worth after a round of investment. Its value after a new cash injection from investors is put in the bank.
For example, if your company is worth $200M before a new round of funding, and your new group of investors puts in $200M in new money, your startup may have a post-money valuation of $400M.
This is still, of course, open to negotiation, and alternative methods of business valuation.
Pre-Money Versus Post-Money Valuations
A pre-money valuation is how much your company is worth before receiving new money in a round from investors. How much it is worth just as it stands before more fundraising.
This involves more common approaches to business valuations, and startup valuation methods.
Then the new money being put in is added to that in order to calculate your startup’s post-money valuation.
Investors will use your pre-money valuation to calculate the percentage of your company they will take in the form of shares when they complete their investment. Or, more specifically, the share price they are paying for that percentage of ownership with your new valuation.
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So, if you have a pre-money valuation of $150M, and they put in $50M in new funding, they are becoming shareholders with a 25% stake or ownership position in your business.
Are you looking for some in-depth information on how to value your company? Check out this video I have created, where I explain in detail how to execute this task. It can make a significant difference in your fundraising efforts.
Why Is Post-Money Valuation So Important?
While calculating a post-money valuation may sound easy, and maybe in some cases, it is highly impactful and can have a variety of effects on and in your business.
Some of these may be obvious. Others may not be, as a newer entrepreneur, in your first or second company.
There may be elements of fundraising that are more important than this paper’s valuation. Though it is essential to understand the influences and consequences of a valuation. Especially the pros and cons of higher versus lower valuations.
The Impact Of Post-Money Valuations On Future Rounds
As we’ll dig deeper in a moment, high post-money valuations can be problematic for some startups when it comes to raising future rounds of capital.
You always want your valuation to be going up. Especially at key moments, like fundraising. Be sure that even if you are accepting a bullish or even perhaps slightly overly generous valuation in this round, you are confident you are on a trajectory that will continue to lift your company’s value for the future.
Otherwise, you will be giving away more of your own shares, and diluting the ownership further. Aside from the fact that your investors may not be pleased that the value of their stock is not increasing.
It is good to have some motivation to keep growing. Just not so much pressure that you end up trying to take shortcuts or turn to short-term thinking and decisions which jeopardize the long-term viability and profitability of your company.
Balance this, with the fact that your investors may truly see far greater potential and value than you can from your perspective. Be sure to ask, and understand what they are basing these numbers on.
Access To Financing
The strength of your balance sheet and other financials can certainly be impactful when it comes to accessing other types of financing as well.
No one wants to finance or loan a bankrupt business. The more equity in the business, the easier borrowing, or opening vital credit facilities will be. Along with the ability to obtain far better terms, and lower costs of borrowing.
The Value Of Your Shares
Of course, the more valuable your company is, and the higher its valuation goes, the more valuable and higher the worth of each of your shares in your company goes.
You may end up with fewer shares, and a smaller percentage of ownership at each round, though it is important to look at the net value of your shares. As well, of course, as any other factors which may impact that value, and what you can do with them.
Terms Versus Valuation
With the above in mind, savvy entrepreneurs, and repeat founders tend to put more priority on negotiating the terms than just the paper valuation.
Valuation is a factor. It can be influential in a variety of ways. Yet, it is the terms of a funding agreement or investment contract, which really lay out the impact of this transaction.
This is why the funding process really starts with a Term Sheet, and the founders and their board are able to review and negotiate the terms, prior to opening up deep due diligence, spending time, more money, and expending resources with a potential investor.
This is one of the most important terms in fundraising. One which few new entrepreneurs understand the gravity of. This is why some have ended up selling their companies for a billion dollars and ended up getting zero, or pretty close to it.
Liquidation preferences refer to who is preferred or prioritized when there is a liquidation event. As well as how much they get. In some cases, investors will want not only their capital back, but guaranteed multiples of that capital, before anyone else, or you, as the founder, get a penny.
So, if your value hasn’t multiplied dramatically, then you might find you are not getting very much for all of the effort, time, and money you are putting into this venture.
Voting rights, board seats, dilution, shares issued, and other factors all impact control of your company.
Outside investors can bring a tremendous amount of value to your startup. They can dramatically rocket your progress, and help you take your company to heights you didn’t even dream of.
That’s if you pick the right investors, and set the right expectations, with the written and legal documentation to ensure that from the beginning.
If you don’t, and you fail to pay attention to or appreciate the fine print, then you may be shocked when your investors take over your business. They can have the right to fire you, adjust and dictate your compensation, and make a wide variety of operational and product decisions.
The Pros & Cons Of A High Valuation
There are both pros and cons to high valuations. Just as there is to everything else in life and business. It is important to know them, and the trade-offs.
The Pros Of High Valuations
Some founders have intentionally looked for supersized rounds of funding and valuations to boost their credibility. If you are raising $100M or have a $1B valuation virtually out of the gate, it suggests you are working on something of value. It will at least get you some attention. Of course, sooner or later, you are going to have to back that up too.
Attracting Top Talent
The best talent wants to work for the best companies. Valuation and fundraising amounts alone may not be directly linked to the underlying quality of the business, though it can be an indicator that many talented workers are watching. Everyone wants to work with the winner. Even more so if they believe your company can afford to pay them well. Especially in an environment where others are making substantial layoffs.
The Cons Of High Valuations
If you cannot top your previous valuation when it comes time to raise again in a few months, you face a down round. Or at least a flat round. Meaning your valuation is flat or has decreased.
This can be due to your own lack of growth, or the ability to establish tangible and measurable value in your company. Or due to external market factors, and overall valuations of shares and businesses crumbling.
This is not good PR. In these cases, you will also likely be giving up more of your own ownership and control over your company. As well as potentially seeing the value of your existing shares decline.
An outsized post-money valuation means it may be harder to keep up attractive growth metrics. You first have to catch up with that valuation, then show hypergrowth on top of that. Especially as an early-stage startup, future investors are going to want to see uncommon, and extreme rates of growth, that will multiply their money.
Keep in mind that in fundraising, storytelling is everything. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
Common Startup Valuation Methods
Common pre-money and post-money valuation methods for startups include the following:
- The Berkus Method
- Share price multiplied by the number of diluted shares
- Pre-money valuation plus new investment cash
- Discounted cash flow method
- Precedent transactions and comparable market transactions
Achieving A Higher Valuation For Your Startup
Fortunately, startup founders do have a lot of control over the valuations assigned to their startups when fundraising.
Some of the ways to do this include the following:
- Bring in more capital in your next funding round, which will directly increase your post-money valuation. Seek larger investors with more money or more investors.
- Improve the metrics that create a more valuable company. Focus on pushing your basic business metrics to increase your pre-money valuation in advance. Including revenues.
- Consider an M&A transaction prior to, or in conjunction with the next round. This can enable you to acquire the metrics you need to show more value, and become a more substantial player in your market.
Then negotiate, negotiate, negotiate. It helps to have a third-party expert act as a buffer in this process. If a higher valuation is really the goal, then you may be willing to make trade-offs in certain terms of the investment. Know your bottom line, and leave room to negotiate, so that everyone feels they are winning something.
Post-money valuation is a very important factor for startups and their founding entrepreneurs. While there are many other things vying for your attention in your startup, understanding pre and post-money valuations, and their impacts on your company now and later is vital for founders.
Get to know how they are calculated, what you can do to change them, and the pros and cons of high and low valuations at each round.
This, as well as mastering negotiating the best terms on each investment, will make all the difference in growing your venture to where you want it to be.
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