A company seeking funding will likely be asked about their pre-money valuation. The pre-money valuation is the company’s value before offering preferred stock financing. The pre-money valuation can be found by multiplying the price per share of the current preferred stock by the fully-diluted capital the company already has. That valuation is an estimate of the company’s worth before securing equity financing and differs from post-money valuation. This figure allows investors to determine the amount of equity available in return for their investment. In the event that a company is receiving several rounds of financing (as opposed to one lump sum investment), pre-money valuation is typically conducted at the beginning of each round.
A pre-money valuation does not show the true value of a company – it shows the amount of the company that an investor will receive for their investment. A company that is valued at $1 million dollars pre-money that receives an investment of $200,000 is worth more than the company valued with post-money. The ownership of the company will be affected by a small percentage, but the long term payoff will be greater if the company were to go public.
A pre-money valuation can become vitally important in a situation where an entrepreneur is seeking venture capital. The entrepreneur may be short in cash but long in ideas, and need to negotiate the value of the company with a potential investor. Using the pre-money valuation calculation, the investor can begin to get an idea of the potential return on their investment, and can make a determination about the feasibility of the investment.
It is important to remember that the pre-money valuation is not the amount that a shareholder would receive in the event of a sale. The valuation is a tool to help establish the investment potential of the company.