“The world is terribly apt to take people at their own valuations”
-Amelia B Edwards
This is the reason that there can be no set formula or method to value something. Premoney valuation and Postmoney valuation are terms that have evolved due to the evolution of this new startup culture and the increase in the number of people wanting to invest in other people’s ideas. These are two valuations or estimates that can be given for a business or a company’s worth. At the time of investment or bringing in more capital into a business, it is necessary to assess the value of that particular business. This assessment is then used to figure out the change in shareholding and the new share of the investors. This is why it becomes critical to use the correct valuation so that the founders may not be cheated or tricked into releasing more equity than is deserving.
Premoney Valuation
Premoney Valuation is the value of the combined assets and gains of the company equated with it’s liabilities and losses before an incoming investment or the company going public or addition of further capital. This is very useful in assessing the share ratios and amount of investments of the shareholders.
For eg. If Mr. Ramkumar is interested in investing INR 5,00,000 into a company called Holyfist Pvt. Ltd. which has a combined asset total of INR 15,00,000 with Liabilities of INR 5,00,000. The Premoney valuation of Holyfist Pvt. Ltd. is not INR 15,00,000 but instead it is INR 10,00,000 because a premoney valuation is the sumtotal of a company’s assets and liabilities without the new investment.
Postmoney Valuation
Postmoney Valuation is the value of the combined assets and gains of the company equated with it’s liabilities and losses plus the incoming investment from the company going public or addition of further capital. This is also very useful in assessing the shareholders’ profit-sharing ratios and the change in the shareholdings.
For eg. If Mr. Ramkumar is interested in investing INR 5,00,000 into a company called Holyfist Pvt. Ltd. which has a combined asset total of INR 15,00,000 with Liabilities of INR 5,00,000. The Postmoney valuation of Holyfist Pvt. Ltd. is not INR 10,00,000 but instead it is INR 15,00,000 as the Postmoney valuation of a company is the final summation of a company’s assets and liabilities along with the new capital or investment that came in.
Calculating Premoney Valuation and Postmoney Valuation
There are various methods of calculating the Premoney valuation and Postmoney valuation of the company and assessing the profit-sharing ratio for the shareholders. There are so many different methods used as the factoring criterion and the weightage of different variables tends to vary from person to person and business to business. The various factors that are relevant while calculating the Equity to be distributed and shareholding of a company can also be looked into.
Some of the different methods of calculating the Premoney valuation and Postmoney valuation have been illustrated in an informative article by Stéphane Nasser. Calculating Postmoney valuation from Premoney valuation should not be difficult at all as postmoney valuation is just added with new investment. There are various online calculators that are used by founders and startups to assist them through the investment process.
Premoney Valuation vs Postmoney Valuation
So, basically a Premoney valuation is the stock or value of the company before an investment or venture capitalist entry and the value of the company after such an investment is known as the Postmoney valuation. The difference between Premoney valuation and Postmoney valuation is very easy to understand. This can be depicted by a very simple formula :-
Postmoney valuation = Premoney valuation + New Funding/Investment
For Eg. If a Venture Capitalist decides to invest $2,500,000 in a business worth $10,000,000; the Premoney valuation of that business is $10,000,000 and the Postmoney Valuation becomes $12,500,000(Sum of the Premoney valuation and New Investment). This simple funda is lost to many people as they keep confusing thee two and end up losing a lot of money and profits due to such misunderstandings.
Investors and Venture Capitalists often try to take advantage of a founder or an entrepreneur’s generic knowledge of finance and investment and use terms like premoney valuation and postmoney valuation to trick unsuspecting founders. For Eg. A potential investor for a company worth INR 10,00,000 wants to invest INR 5,00,000 into such business. He tells the founders that he shall invest INR 5,00,000 for a share into the business with a Premoney valuation of INR 10,00,000. This in turn makes the share of this new investor 50% which should have actually been INR 5,00,000 for a share in the business having Postmoneyvaluation of INR 15,00,000 which is the actual 33.33% share.
Conclusion
Confucius, the great Chinese teacher and philosopher had said :-
“Real knowledge is to know the extent of one’s ignorance”.
Being a founder, the person like a father to his child, owes it to his business to know about anything and everything related to it.
If entrepreneurs at least start accepting that there is a lot more to investment than the simple addition of money and capital to the business then nobody will be able to cheat and take away their passion. Many a founder also falls prey to the age old tendency of judging a book by it’s cover and involuntarily accepts the term sheet with the highest Premoney valuation without going through the rest of the term sheet.
Awareness is the key to success for a business.