A:

The short answer to the question is that they differ in timing of valuation. Both pre-money and post-money are valuation measures of companies. Pre-money refers to a company's value before it receives outside financing or the latest round of financing, while post-money refers to its value after it gets outside funds or its latest capital injection. Pre-money valuation refers to the value of a company not including external funding or the latest round of funding. Post-money valuation, then, includes outside financing or the latest injection. It is important to know which is being referred to as they are critical concepts in valuation.

Let's explain the difference by using an example. Suppose that an investor is looking to invest in a hi-tech startup. The entrepreneur and the investor both agree that the company is worth $1 million and the investor will put in $250,000.

The ownership percentages will depend on whether this is a $1 million pre-money or post-money valuation. If the $1 million valuation is pre-money, the company is valued at $1 million before the investment and after investment will be valued at $1.25 million. If the $1 million valuation takes into consideration the $250,000 investment, it is referred to as post-money.

prepost1.gif

As you can see, the valuation method used can affect the ownership percentages in a big way. This is due to the amount of value being placed on the company before investment. If a company is valued at $1 million, it is worth more if the valuation is pre-money compared to post-money because the pre-money valuation does not include the $250,000 invested. While this ends up affecting the entrepreneur's ownership by a small percentage of 5%, it can represent millions of dollars if the company goes public.

This topic gets very important in situations where an entrepreneur has a good idea but few assets. In such cases, it's very hard to determine what the company is actually worth and valuation becomes a subject of negotiation between the entrepreneur and the venture capitalist.

(For further reading on this concept, see our IPO Basics tutorial.)

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