In a recent Leapfunder article you learned about The Most Important Things in a Shareholders’ Agreement. Today, Tienko Rasker, Leapfunder’s CEO, talks about pre and post-money valuation.
What’s the difference between pre and post money valuation?
It’s very important to understand the difference between pre-money vs. post-money valuation. Here’s how to wrap your head around it: your company has a certain worth before a funding round, that’s the pre-money valuation.
Let’s say it’s worth €2 million pre-money. When you take on an investment round, say €100.000, then that amount will simply sit on your company’s bank account on day one. That means the company is now instantly worth €2.1 million. That last value of €2.1 million is called the post-money valuation.
The difference between the pre and the post-money valuation is precisely the amount of cash that’s invested in the course of an investment round.
That seems easy enough, but it is a cause of considerable confusion. Thinking about your investment round of €100.000: if the investor agreed to €2 million pre-money valuation, he/she automatically agreed to €2.1 million post-money valuation. That means that he/she should accept that the percentage of the company that he/she eventually gets is €100.000 divided by €2.1 million = 1/21 of the company. You will sometimes meet investors who are puzzled by this. Since they invested at a valuation of €2 million they may expect to receive €100.000 divided by €2 million = 1/20 of the company. Of course, experienced investors and entrepreneurs will always make it clear in all their communication whether any valuation is intended as pre- or post-money. That prevents any future surprises.
What’s a fully diluted pre and post money valuation?
You will sometimes hear of a Fully Diluted Post-Money valuation. What does that mean? ‘Fully diluted’ means that you should pretend that all outstanding options, convertibles, and other financial instruments that could one day turn into shares, have been exercised and have turned into shares. Often, a startup has an option scheme for its team members. The phrase ‘fully diluted’ means that you treat all the options as if they were shares. Often, a startup has convertibles outstanding: to get to the fully diluted valuation you pretend that all those convertibles have been turned into shares.
The fully diluted post-money valuation is a popular measure of valuation with investors. Imagine a startup with a pre-money valuation of €2 million. Let’s say the startup has a 10% option scheme. That means the fully diluted pre-money valuation is 10% higher at €2,2 million. And the fully diluted post-money valuation after the €100.000 investment is, therefore, €2,3 million. You will find that many experienced investors like to talk about the fully diluted post-money valuation of €2,3 million from the beginning. This number is handy for them: if they divide their investment by this number they get a clear indication of what % of the company they really own. In this case, they own €100.000 divided by €2.3 million = 1/23 of the company. That’s the share they will actually get when there is an exit, after the option holders and the founding shareholders get their cash.
To learn if you need a notary for your seed round, stay tuned for the next blogs by Leapfunder!