What is the importance of pre-money valuation For Your Business?

Pre-money valuation is a company’s liquidity before it earns the cash from an investment round. With the contribution of cash to the balance sheet of a business through the shareholder value, the post-money value becomes stronger due to the additional cash earned.

Importance of Pre Money Valuation

A pre-money valuation calculator by calculators.tech helps finance professionals to precisely measure the profit that they will earn after specific investment. Although pre-money evaluation is essential, it is not the most important consideration when taking money, especially when taking it from venture capital. Most of the time, the deals offered by companies are pre-money valuation.

The value-added that an investor will bring to the table is especially important for venture companies for the first time. Startups should take the lower pre-money bid if this business has the potential for a much larger value-added than another, offering better pre-money funding, but the added value opportunity is not the same. The long-term effects of the added value are more than compensatory to the lower pre-money.

Example of Pre Money Valuation

The following is an example of a business undertaking a finance process and its pre-money valuation.

Let’s suppose there is a company with a pre-money valuation of $100 million. There are a total four million shares in the company. The price of a single share will $25. Now the company wants to increase $40 million to the existing equity. So, the company has to release 1.2 million extra shares. Company will add $40 million in its pre-money valuation of $100 million, the post-money valuation will become $140 million. Now, the company has 5.6 million shares, but the price of shares is the same, $25.

Share Price and Equity Value

The pre-money valuation is calculated for the equity of entire business. It does not apply to the share price of the company. Although the capital stock is influenced by the acquisition of extra cash, the share price is not affected.

Equity Value and Enterprise Value

The enterprise value of a company is the market value of a business. It does not include the capital structure. It should be noted that a round of financing does not influence an enterprise’s value. As the equity value of a business rises in the capital, the enterprise value tends to remain the same.

Effect on shareholders

It is important to emphasize that before the transaction, the current shareholders will be reduced in ownership percentage by issuing new shares. The founders had 1 million shares, or 25% of the total shares, before increasing the equity value in the above case. After the increase in equity, founders will have the same 1 million shares but 17.85% of total shares (5.6 million). On the other hand, value of the shares of the founders will remain same.

Valuation of Equity Shares

There are three methods for the valuation of equity shares based on the balance sheet.

Book Value

Book value is the total value of a company split into several remaining shares. You can calculate the net worth by adding equity and reserves of the company minus expenses.

Liquidation Value

Liquidation value is calculated differently from the above-stated book value. It uses the valuation of the liquidation funds, which are often less than the books and market. For the calculation of the liquidation value of the company, liabilities are excluded from the liquidation value of the assets.

Replacement Cost

Replacement costs offer another method to evaluate the valuation of a business. The substitution or current cost of an asset is the amount of money to substitute the asset by purchasing a similar asset with the same future capabilities. Assets and liabilities in replacement costs are measured at their replacement value.

Venture Capital Pre-money Valuation

The valuation of the cash obtained from a funding round significantly affect the equity value of the new companies. That is why the statement is used so often because a business could see a dramatic change in its valuation.

Methods of Valuation

If a company undergoes a funding process, it will have to address the value of the company with investors. Investors can make strong arguments if they don’t find the value of company according to their expectations.

There are several methods for the valuation of a business or a company.

• Precedent Transactions
• Comparable Companies
• Discounted Cash Flow

Formulas for Pre and Post Money Valuation

There is no standard method for estimating pre-money valuations of a company because they completely depend on the worth of the business.

Post Money Valuation

Post Money Value = Pre Money Value + Value of Cash Added

Pre Money Share Price

Pre Money Share Price = Post Money Value / (Previous Shares + New Shares)

Filling Gaps of Valuation

Since a company’s worth can be debated extensively, and investors usually expect a highly optimistic market, Venture Capital companies typically utilize preferred shares to address the valuation discrepancies.

There are a lot of advantages for venture capital companies to receive preferred shares.

• Participation rights can be further enhanced
• Anti-dilution privileges may secure the share from further dilution
• Preference for liquidity is the first paying out when the company is sold
• Preferred returns have a preferred investment return rate

Since all of the characteristics above have an added value, the preferred shares of the venture capital business are worth more than the rest. This ensures that they are willing only to buy preferred shares that are more expensive at a less desirable common share level, rendering their return on investment more appealing.

Wrapping-up

Financial planning doesn’t leave an investor comfortable until his/her business performs as per expectations. It is something that follows and sticks with you throughout your career, even if you are planning for a startup or a company with thousands of employees. You should probably hand it over at one stage to a professional who doesn’t just learn but love to do that. You must get to know the mechanism until then.