By Patrick Rogers / Scale Up - Image Credit : Investopedia
SOURCE : Scale Up - PRE-MONEY VS POST-MONEY: WHAT YOU NEED TO KNOW
During VC investment round, you've probably heard about the "Pre-money" and "Post-Money" terms but what do they really mean ? Funding rounds bring with them a key and new vocabulary and terms you need to get familiar with. As a founder, these terms are central to your bottom line, so you should understand what they mean, what they represent and how they impact the financing of your company.
First up. Why do I need to know about this?
Valuation will be a big negotiation point between you and your VC investor: valuation discussions are speculative and will be driven by market forces. Entrepreneurs and investors usually have differing estimates of valuation. Existing shareholders want a high valuation, so they suffer less dilution after the investment round. Investors prefer a low valuation, so they can maximise the ownership percentage they receive for their investment.
Valuations directly impact the percentage of the company which existing shareholders will retain and what percentage an investor will receive for that investment. Think carefully about what you mean when you use the terms Pre-money and Post-money and how each phrase may support a particular number.
What is the difference between Pre-money and Post-money?
Both are valuation measures of companies, but they differ in the timing of the valuation. Pre-money is the valuation of your business prior to an investment round. Post-money is the value of your business after an investment round. Post-money is simpler for investors, but pre-money valuations are more commonly used.
So, in a nutshell:
Post-money = Pre-money + money received during the investment round
Why are Post-money valuations simpler?
The valuation of the business is fixed. In a Pre-money scenario, the value of the business can float with variables e.g. ESOP expansion, debt-to-equity conversions and pro-rata participation rights. Pro-rata participation rights are the right, but not the obligation, to invest in future rounds to maintain the same ownership proportion. Convertibles (e.g. convertible loan notes, SAFEs and KISSes) are becoming more common for seed investment and the face value of these instruments are added to the Post-money valuation at the time of investment.
You and your co-founder incorporate a company. The company issues 1,000,000 shares which are divided equally between the two shareholders (you hold 50% of the shares, your co-founder owns the other 50%). The company is successful and now you need additional capital. An investor offers you USD 250,000 for shares in the company on a valuation of USD 1,000,000. The ownership percentages of the founders and the investor will depend on whether this USD 1,000,000 valuation is Pre-money or Post-money, as illustrated in this table: