‍Today’s topic: dissecting the difference between pre-money and post-money valuations. And yes, this does matter.

Today’s topic might sound kinda boring. Pre-money vs post-money … doesn’t it all come out in the wash when the company IPOs?

Actually, no. Understanding the difference between these concepts is critical for investors, especially at the early stage, where your shares will almost certainly get diluted down as the company advances.

So, let’s dive in.

We’ve all seen these terms printed at the top of a term sheet:

If you’re thinking, “I mostly only invest in SAFEs”, you should also listen up. The pre-money and post-money consideration also applies to SAFEs. We’ll get into that later. 

But does the “money” part really matter? We all understand conceptually what the “valuation” part means, isn’t that good enough?

Well, not really. 

There’s actually a meaningful difference between a startup valued on a pre-money basis versus one valued on a post-money basis.

As an investor, we make investment decisions based on our analysis of the company. Do we think the business has a great shot at growing big enough to provide a meaningful ROI?

But we also have to think about the company’s valuation. This is not something to skate over. Even if you love the team, the problem, the market, and the product, investing in the biz might be a terrible business decision if the valuation isn’t attractive enough.

The key here is understanding the difference between “pre-money valuation” and “post-money valuation”. 

Pre-money Valuation

When you think of calculating valuation, you might picture long, intricate spreadsheets. But that’s not the case when it comes to pre-money valuations. 

Pre-money valuations are often hotly negotiated between the startup founder and the lead investor of the round. It’ll take into consideration what other companies are being priced at, the company’s growth rate, how strong the founding team is, early traction, the company’s geography, and more. At the end of the day, this valuation is speculative. 

A company’s pre-money valuation will help determine the price per share (PPS) that investors are buying shares at. 

Basically what this means is: 

Companies are made up of a bunch of little shares. When you invest in a company, you are buying shares. Those shares each have a price that you pay for them. As an investor, the lower the price the better, as this gives you the potential for higher returns. 

As an investor, the pre-money valuation is one of two inputs that determine the PPS you’ll pay for your preferred shares. 

Pre-money valuation / fully diluted capitalization table = PPS

Wait a second, fully diluted capitalization table? 

This is a fancy term to tell you how many shares there are in the company. Specifically, it includes the number of shares the company has already issued, plus any shares that have been authorized and may be issued in the future. 

So, how is the number of shares in a company calculated? Let’s just say that getting to the final number of shares can be complex, and is often negotiated with the lead investor of the financing round. 

The big distinction between pre-money valuation and post-money valuation is that pre-money valuation does not include any invested capital in the current round. 

It’s the valuation of the company before any new capital is invested. 

So, what do we know about pre-money valuation? It helps us find the exact price we’re buying shares at, but doesn’t allow us to know what percentage of the company we’ll own because it doesn’t consider any invested capital in the current round. 

Post-money Valuation

Unlike a pre-money valuation, the post-money valuation of a company can tell an investor their exact percentage ownership in the company based on their investment amount. This type of valuation includes the invested capital of the current round and can be calculated by adding the pre-money valuation + invested capital. 

So if a founder is raising $2m and negotiates with the lead investor for an $18m pre-money valuation, this means that the post-money valuation is $20m. 

You can also use this calculation to find the post-money valuation:

Financing raised / percentage ownership = post-money valuation

So if an investor offers a company $2m in exchange for a 10% stake in the company, the investor is valuing the company at a $20m post-money valuation ($2m/10% = $20m)

Which valuation is used more?

Pre-money equity valuations are more common for a couple of reasons:

1. Investors can clearly understand the price per share when they’re deciding how much to invest. 
2. Using a post-money equity valuation would mean that the exact size of the round is agreed on and won’t change. 

This rarely happens because the size of the round will fluctuate based on investors increasing or decreasing their allocations. So it’s hard to know exactly how big the round will be until it’s officially over. 

Pre-money vs Post-money SAFEs

Angel investors and early-stage VCs will come across a ton of SAFE deals.

Luckily, the pre-money vs post-money dilemma is no stranger to SAFEs. SAFEs are either raised on a pre-money or a post-money basis, similar to equity rounds. Like equity rounds, it is crucial for early-stage investors to fully understand the differences. 

When YC launched the SAFE in 2013, it was structured as a pre-money SAFE. With a pre-money SAFE, it’s not possible for an investor to determine their percentage ownership heading into the next financing round. 

This is because, at the next financing round, all SAFE holders will have their investments converted to equity. When that happens, each SAFE holder will dilute each other. So when an investor purchases a pre-money SAFE in a company’s pre-seed round, it’s really a guessing game as to what amount of ownership the investment will turn into in the future. 

To fix some of these problems, YC introduced the post-money SAFE in 2018. Post-money SAFEs make it easier for investors to understand their percentage of ownership in the company at the time they invest. 

For example:

If you invest $1m on a $10m post-money SAFE, you are locking in a 10% ownership stake in the company when the SAFE converts immediately prior to the next round. 

🚨 Remember: post-money SAFE holders will be diluted by the next round’s investors. But post-money SAFE holders will not be diluted by existing SAFE holders. 

This helps investors understand what their ownership stake is at the point of making an investment in a post-money SAFE. 

This is why post-money SAFEs are more commonly used than pre-money SAFEs.

Please think about valuation in your analysis

Valuation plays a big role in your investment analysis. Or at least, it should.

Angel investors and VCs do due diligence when deciding if investing in a company is right for them. Part of due diligence is not only knowing if you want to invest in a company, but also knowing if you want to invest at the given valuation. 

To decide if a company’s valuation makes sense, it’s often helpful to look at other companies, then compare. Companies with recent funding announcements, publicly traded companies, and historical industry valuations are all helpful metrics to use as a benchmark when evaluating a given investment opportunity. 

Okay, that was a lot. 

TLDR: there’s an important difference between pre-money and post-money valuations for equity rounds and SAFEs.

Make sure you’re aware of which type of valuation you’re being asked to invest in before making a commitment, especially if you see something out of the ordinary. 

And remember, pre-money → common for equity rounds; post-money → common for SAFE rounds. 

This article was written by Tucker McKay. Tucker is the founder of Ikaria Labs, a content marketing agency for funds, fintechs, and financial services companies.