What is the Post-Money Valuation?
Post-money valuation is a company's estimated worth after outside financing and/or capital injections are added to its balance sheet. Post-money valuation refers to the approximate market value given to a start-up after a round of financing from venture capitalists or angel investors have been completed. Valuations that are calculated before these funds are added are called pre-money valuations. The post-money valuation is equal to the pre-money valuation plus the amount of any new equity received from outside investors.
Understanding Post-Money Valuation
Investors such as venture capitalists and angel investors use pre-money valuations to determine the amount of equity they need to secure in exchange for any capital injection. For example, assume a company has a $100 million pre-money valuation. A venture capitalist puts $25 million into the company, creating a post-money valuation of $125 million (the $100 million pre-money valuation plus the investor's $25 million). In a very basic scenario, the investor would then have a 20% interest in the company, since $25 million is equal to one-fifth of the post-money valuation of $125 million.
The scenario above assumes that the venture capitalist and the entrepreneur are in total agreement about the pre and post-money valuations. In reality, there is a lot of negotiation, particularly when companies are small with relatively little in the way of assets or intellectual property. As private companies grow, they are better able to dictate the terms of their financing round valuations, but not all companies reach this point.
Importance of Post-Money Valuation to Financing Rounds
In subsequent rounds of financing of a growing private company, dilution becomes an issue. Careful founders and early investors, to the extent possible, will take care in negotiating terms that balance new equity with acceptable dilution levels. Additional equity raises may involve liquidation preferences from preferred stock. Other types of financing such as warrants, convertible notes, and stock options must be considered, if applicable, in dilution calculations.
In a new equity raise, if the pre-money valuation is greater than the last post-money valuation, it is called an "up round." A "down round" is the opposite, when pre-money valuation is lower than post-money valuation. Founders and existing investors are finely attuned to up and down round scenarios. This is because financing in a down round usually results in dilution for existing investors in real terms. As a result, financing in a down round is often seen as somewhat desperate on the part of the company. Financing in an up round, however, there is less reluctance as the company is seen as growing towards the future valuation it will hold on the open market when it eventually goes public.
There is also a situation called a flat round, where the pre-money valuation for the round and the post-money valuation of the previous round are roughly equal. As with a down round, venture capitalists usually prefer to see signs of an increasing valuation before putting in more money.