Startups pre-money-valuation

Published on April 4th, 2011 | by Tod Whipple

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Pre Money Valuation




pre-money-valuation

Chances are if your researching the term pre money valuation then you are about to accept outside venture capital in your startup or business.

Pre money valuation is not a dark or mysterious term, but an essential component of a startup term sheet to determine valuation before outside money is infused in your company. The pre money valuation will determine how much ownership or percentage of your business an outside investor will take in exchange for the amount invested.

For example, lets say you have bootstrapped your company to profitability (or potential of profitability in many startups) and have a pre money valuation of $1 million. You are looking to raise $3 million dollars to scale and bring your company to the next level. You decide to take the Venture Capital investment of $3,000,000 and divide by the post money valuation of $4,000,000(1M + 3M). As a result you will give up 75% of the equity of your business in exchange for the $3 million dollars of investment. Before you freak remember that you still own a $1,000,000 worth of your company and likely have aligned interests to potentially make your company worth $10 million.

The only fly in the ointment is how the heck do you determine pre money valuation correctly?

Depending on the type of business it can more be more art than science. If you have a startup with huge potential but not much revenue to match (think facebook initially) it can be even more subjective.

There are some more traditional methods used to determine valuation. In the CCIM world we use Discounted Cash Flow (DCF) analysis as a method of taking future cashflows for commercial real estate ( can apply to a business) and discount all those cashflows for risk (this is a percentage rate) to determine a present day value for the business (Know as Net Present Value). This method will work well for pre money valuation on businesses with historical earnings and data but will be virtually useless for startups.

Determine if you have revenue or not. If yes, DCF and other traditional methods like asset value method (AVM) etc. may work well. If no, then you are in the startup category and market demand and acceptance of your product along with a growing customer base will likely determine your value. At the end of the day the market will determine the value of your company (or VCs will). Just remember, there are many deal points in a startup term sheet and pre money valuation is just one component.

Be sure to seek salient advice from legal and mentors to be sure all your terms are fair with a Venture Capital firm. Going with the VC firm that offers the highest pre money valuation doesn’t necessary mean an investment fit if you are getting hosed on the other deal points.

* Please not this is not legal advice in any form and you should consult a seasoned startup or M&A attorney when dealing with term sheets.*



 


About the Author

A serial entrepreneur. Founder of Startup Addict. Commercial Real Estate Expert. Technology Ninja. Movie & television producer. Lover of all things Business. He has a Black Belt in "Keep'in it Real". Connect with Tod on LinkedIn or follow him at @todwhipple or @startupaddict.



3 Responses to Pre Money Valuation

  1. Alan Lobock says:

    As a serial entrepreneur (co-founder of SkyMall, Inc. and others), I have personally struggled with the challenge of computing a defendable pre-money valuation. Recently, I co-founded a company that is building an online tool that will guide an entrepreneur through a series of screens, collecting key inputs that our system will use to compute a pre-money valuation using a blend of the methods most frequently used in the venture world coupled with other relevant and recognized techniques. Users will receive a detailed pre-money valuation report that they may, if they wis, share with prospective investors when asked the daunting and inevitable question, “How did you come up with your company’s value?” We will be launching a free private beta; register to participate at http://www.pmvtool.com. We welcome your feedback.

    • Tod Whipple says:

      Hi Alan,

      Pre-money valuation is a much art as it is science for sure. Entrepreneurs and Investors alike could benefit tremendously from your tool. I look forward to giving your pre-money valuation tool a spin. Best of Luck.

  2. Alan Lobock says:

    As a serial entrepreneur (co-founder of SkyMall, Inc. and others), I have personally struggled with the challenge of computing a defendable pre-money valuation. Recently, I co-founded a company that is building an online tool that will guide an entrepreneur through a series of screens, collecting key inputs that our system will use to compute a pre-money valuation using a blend of the methods most frequently used in the venture world coupled with other relevant and recognized techniques. The result will be a report an entrepreneur

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