Question

Explain the difference between pre-money valuation and post-money valuation. Why is valuation important as the company raises additional rounds of financing?

Answer 1

Pre-money and post-money valuation are the two different measures used in valuation of a company.

Pre-money valuation means valuation of the company prior to its investment (i.e. valuation done before it receives cash through financing)
Post-money valuation means valuation of the company after it receives cash and investments into it.
i.e; Post-money = Pre-money + Cash recevied (Investments)

Here is an example;
A and B are two shareholders of a company having an equal share. The company;s worth is $10,00,000. An investment is made by C of $3,00,000.

Pre-money valuation	Post-money valuation
Initial value	$10,00,000	77%	Initial value	$7,00,000	70%
Investment	$3,00,000	23%	Investment	$3,00,000	30%
Total	$13,00,000	100%	Total	$10,00,000	100%

The ownership percentage of A and B will depend upon whether $10,00,000 valuation is pre-money or post-money.
If the valuation is pre-money, then the company is valued at $10,00,000 before investment and will be valued at $13,00,000 after the investment.
If the valuation is post-money, then the company is valued at $10,00,000 including the investment $3,00,000.
Hence, the total difference in the ownership of A and B in both valuation is 7% (3.5% each)

There can occur a similar variation(like in the above example) in the percentage of ownership when the valuation is pre-money or post-money.