Are we talking pre- or post-money valuation, and do they mean equity or enterprise value?

Or, you don’t know what you don’t know.

So, you have 50 kUSD that you are ready to invest in a new start-up. How much should you get from the company then? That is the question of what the company is worth.

When investing in a start-up, there are many terms you will need to get a grip on. These terms, and the rules that apply, will of course be as every day as to how to drive a car when you are familiar with them. But it is ok not to know – and for all the questions I get, I thought I would put together a short 101 on addressing the terminology.

Pre-money

Typically, valuations are presented as pre-money – “this is how much we think the company is worth today”. What it is worth before you (and other investors) have injected the fresh capital into it. Let’s in our case say that we are looking at a pre-revenue start-up that has done one funding round some eleven months ago. That round was made at a valuation of 3 MUSD due to the strong management team and the innovative new business concept that was supported by a strategic building of brand equity.

A rational model for pre-money valuation for your round would be the last investment round valuation plus any value-added during the 11 months. For instance, have they done 2 pilot projects providing proof of concept, or have they already outperformed on their customer acquisition? Let say we end up with a pre-money valuation of 5 MUSD.

Post-money

Your ownership stake will however be based on the post-money valuation – i.e. the pre-money valuation plus the amount of money paid into the company in that funding round. In this case, there are four Angel Investors, each putting in 50 kUSD and a VC that is willing to match that with 200 kUSD. Total invested amount being 50k * 4 + 200k = 400 kUSD. The post-money is then pre-money plus the 400 kUSD = 5.4 MUSD.

Enterprise value or equity value?

With the above in mind – you should also consider enterprise value versus equity value. Simply put, enterprise value is the value of the company as such. Equity value is the enterprise value plus/minus cash and debt. You should always be careful to ensure that you and the other party are both discussing and agreeing on the same thing – pre-money enterprise value or pre-money equity value. Why? Imagine that you thought that the pre-money value was 5 MUSD and that this was equity value. The founders however felt they meant the enterprise value all along – and that a cash position of 0.5 MUSD should be included in the calculation, leaving you with a significantly lower stake for your investment. Typically, it is the equity value that is discussed – but is sure you make it right!

Your share position?

Will be your investment divided by the post-money value (equity value as the pre-money base). 50 kUSD / 5.4 MUSD = south of 1 % of the company is yours!

Value adjustments?

An investor also needs to consider the dilutive effect of outstanding options, convertibles, employee incentive plans, etc. Note that there are different approaches to how to refer to employee options, debt instruments, etc. So make sure that you understand what the fully diluted valuation is.

As a fresh example: Company A offers an investment of USD 100k at a pre-money valuation of USD 1m. Company A has issued a stock option to its employees corresponding to 5% of the total number of shares prior to the investment. The investor makes the investments and receives approx. 9.1% of the outstanding shares. However, on a fully diluted basis (i.e. assuming that all stock options are exercised) the investor will hold 8.7% of the company – N.B. while a number of the options outstanding can be expected to lapse (due to departures, not meeting vesting criteria, etc) the option pool instruments will many times be recycled and offered to new employees, etc. So from an investor’s perspective, it is often most prudent to regard all option instruments as having been issued.

Valuation and new funding rounds’ effect on your share

You typically cannot defend your ownership percentage forever – so you will at some point in time be diluted. This means that your control goes down, BUT your value will typically go up. Central for your returns is the price per share. If the price per share goes up, your stake will become worth more – even if you are heavily diluted percentage-wise.

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