Almost all of my clients have asked me questions about valuation. These questions are usually why is it important, how do I determine it, and what is the difference between pre-money and post-money? The purpose of this post is to answer all of those questions and hopefully shed some light on an often confusing concept. As always, please discuss with your attorney any questions you may have in regards to the value of your business and how it affects your specific round of financing.
Why it is important:
When negotiating with an investor, the first question they normally ask after your pitch is “what is the valuation?”. It is important that you have a well thought out and realistic number for your answer.
How to determine valuation:
There are many different ways to determine the valuation of your business. You can look at the amount of assets the business has, its yearly revenue, a multiple of its yearly revenue, or use a discounted cash flow analysis. These simple valuation tools can help you get a rough estimate of how much your business is worth.
Pre-Money and Post-Money:
When negotiating with an investor, it is important to note that they like to distinguish their offers between pre-money and post-money. Pre-money is the value of the company before investment, and post-money is the value of the company after investment. For example, an investor can say I will put in $2 million at a pre-money valuation of $3 million. What this means is the investor currently values the company at $3 million. Their $2 million investment will put the company at a $5 million post-money valuation. When discussing valuation with an investor, be sure you clarify whether they are talking about the pre-money or post-money valuation. This important clarification is one that is often missed by founders and can lead to a few surprises when closing a round.