Don't make a costly mistake when discussing valuation with savvy investors
Investors often have two ways to talk about valuation, and this sometimes confuses entrepreneurs raising funds.
The difference can amount to quite a few percentage points in dilution, so it’s important to be clear about it.
It's easy once you know the basics.
Pre-money valuation is the value of 100% of your company’s shares BEFORE the fundraising is complete.
If you add to it the money being raised, you get the POST-MONEY valuation of the company.
If you raise $1M at a $2M pre-money valuation, your post-money valuation is (yes…) $3M.
The percentage the investor gets is calculated on the POST-MONEY valuation.
Here, the shareholder gets 1/3 of the company’s shares — and not 50%, as commonly believed.
If an investor says:
“I want 20% of the company for $200,000”
It means the POST-MONEY valuation is $1M, and the pre-money valuation is… $800,000.
You will, therefore, issue shares based on that valuation.
Assuming you have 100,000 shares outstanding, each share is worth $8, and since you need to raise $200,000 you will issue 25,000 new shares.
In the end, you still own 100,000 shares but out of a total 125,000, so you now own 80% of the company, and the investor the remainder or 20%.
It will take some practice but you will quickly become an expert at pre- and post-money valuations.