Pre-money valuation vs. post-money valuation
Pre-Money vs. Post-Money Valuation: Why VCs Use Pre-Money Internally
When venture capitalists (VCs) negotiate investment deals, they often highlight post-money valuation to founders—it’s a bigger number and tends to sound more impressive. However, behind the scenes, VCs rely on pre-money valuation for internal calculations and decision-making. One key reason for this is the flexibility it provides in "pricing" the business independently of the actual investment size.
Pre-Money vs. Post-Money: A Quick Recap
- Pre-Money Valuation: The company’s value before new capital is added.
- Post-Money Valuation: The pre-money valuation plus the amount of new investment.
Example: If a company is valued at $10M pre-money and a VC invests $2M, the post-money valuation is $12M.
Why VCs Use Post-Money in Negotiations
When pitching terms to founders, VCs often frame deals using the post-money valuation. Why?
- It’s a Bigger Number
Saying, “We’re investing at a $12M post-money valuation,” sounds more appealing than emphasizing the $10M pre-money valuation. It subtly inflates the perceived value of the deal from the founder's perspective. - Simplifies Equity Conversations
Post-money valuation directly ties to ownership percentages. For instance, with a $12M post-money valuation and a $2M investment, the VC owns 2/12=16.67%. This is an easier number to communicate during initial discussions.
Why Pre-Money Matters More Internally
VCs focus on pre-money valuation internally because it provides a stable and independent measure of the company’s worth. Here’s why this is crucial:
1. Independence from Round Size
The pre-money valuation reflects the intrinsic value of the company before considering how much capital will be injected. This allows VCs to “price” the business based on its fundamentals—market opportunity, traction, team, and growth potential—without being influenced by how much they (or co-investors) decide to invest.
- For example, whether a VC invests $1M or $5M, the pre-money valuation remains $10M.
- This independence ensures that the valuation reflects the business’s actual worth, not the funding dynamics.
2. Flexibility During Negotiations
The size of a funding round often changes during negotiations, as co-investors join or founders adjust their capital needs. By anchoring on the pre-money valuation, VCs can maintain consistent pricing for the company regardless of these fluctuations.
3. Portfolio Strategy and Benchmarking
Using pre-money valuation helps VCs compare opportunities across their portfolio and ensure alignment with their investment thesis. It provides a clean metric that isn’t distorted by the size of individual deals.
4. Accurate Dilution Analysis
Pre-money valuation simplifies the math for determining dilution. Since post-money valuation fluctuates with the investment size, anchoring on pre-money ensures that ownership calculations are tied to a fixed business valuation.
Why This Matters for Founders
Founders should understand that while post-money valuation may sound impressive, pre-money valuation is the true indicator of how investors are pricing their business. To negotiate effectively, it’s essential to focus on the pre-money figure, as it directly impacts dilution and sets the baseline for future funding rounds.
The Bottom Line
For VCs, pre-money valuation is a stable, reliable tool for pricing a company independently of the round size. It allows them to focus on the intrinsic value of the business, unaffected by shifting investment amounts or participation from co-investors.
While post-money valuation dominates deal headlines, pre-money valuation is the real driver of how businesses are assessed and valued internally. Understanding this dual approach gives founders an edge in navigating the negotiation process and building long-term value.