Valuations are a tricky thing. Too often entrepreneurs don't understand the difference between pre-money and post-money valuations.
Often times, the explanations that I hear given to these entrepreneurs are more confusing than the questions.
So here is a simple breakdown for any entrepreneurs out there trying to figure out how to calculate the pre-money and post- money valuations:
Given that someone is raising $5 million for 33.3% equity:
The post-money valuation is $15M ($5M X 3 = $15M).
The pre-money valuation is $10M.
Why is the pre-money valuation $10M?
Before the $5M was invested, the company wasn’t worth $15 million. This is because when the $5M is added to the company’s balance sheet the company has just increased its value by $5M. (read more on Balance Sheets and Accounting 101 here).
Now that we have the post-money valuation ($15M), in order to calculate the pre-money valuation you need subtract the amount of investment ($5M) from the post-money valuation ($15M).
In this example, the company is being valued at $10M. This is calculated by taking the $15M post-money valuation and subtracting the investment ($5 million). This results in a value of the company, as it exists before your investment. In this example, that value, which is the pre-money value is $10M.
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