Pre-money valuations are an incredibly important first step for early-stage startups. They affect everything from how much money you can raise, to the percentage of your company that investors will own, to the valuation at which you can sell your company or take it public.
Here, we’ll be giving you an overview of pre-money valuations: what they are, how to calculate them, and what factors will impact your company’s pre-money valuation.
What Is Pre-Money Valuation?
Pre-money valuation is the process of estimating a company’s monetary value before it takes on any outside investment, such as:
- issuing equity to new investors
- selling convertible debt
- participating in a merger or acquisition
Pre-money valuation is important because it sets the stage for how much new investment a company can take on, and at what price. It also impacts the post-money valuation, which is the total value of a company after new investment has been added.
Pre-money valuation is typically done by professional investors, such as venture capitalists (VCs) or angel investors. But, it’s also something that every founder should understand, even if they’re not actively seeking investment.
Pre-Money Valuation vs. Post-Money Valuation
- Pre-money valuation is the value of a company before it takes on new investment.
- Post-money valuation is the value of a company after it takes on new investment.
For example, let’s say that a company has a pre-money valuation of $10 million. They then go on to raise $5 million from investors. The post-money valuation of the company would be $15 million ($10 million pre-money + $5 million raised).
How To Calculate Pre-Money Valuation
Unfortunately, there isn’t a formula for calculating pre-money valuation like there is for post-money valuation. This is because seed-stage companies often have very little financial KPIs to work with.
Instead, pre-money valuation is calculated using a subjective approach that often considers several factors, including:
- Available Financials: This will include any KPIs or financial statements that are available, such as revenue, burn rate, or runway.
- Comparable Companies: This method looks at similar companies that have recently raised money and compares their valuations. This is also known as the “market approach.”
- Discounted Cash Flow (DCF): This method estimates a company’s future cash flows and discounts them back to today’s value.
- Company Culture and Team: This method looks at qualitative factors, such as a company’s culture, the strength of its team, and its overall growth potential.
- Investor Interest: This method looks at how much interest investors have shown in the company and whether there’s likely to be a competitive bidding process. Founders often use strong interest as leverage.
In most cases, pre-money valuation will be a combination of these methods. It’s arrived at when the investors and founders are able to compromise on a valuation—usually after a bit of negotiation.
Founders make their case for why their company is worth a certain amount, while investors do the same for why it’s only worth what they’re willing to pay.
Determining Pre-Money Valuation Is Challenging
Ultimately, determining your startup’s pre-money valuation is a challenging process that involves a good deal of negotiation and considers multiple factors. But understanding the process is key if you want the outcome of these negotiations to be optimal!
For more advice about navigating the tricky world of seed-stage startups, why not book a call with one of our Growth Mentors?