Understanding the concept of pre-money and post-money valuation: What every investor needs to know
Investing in a startup is not just about writing a check: it requires a detailed understanding of financial concepts, including valuation. The notions of pre-money and post-money are not just financial terms: they influence the shares that shareholders hold, the dynamics between investors and founders, and even the strategic prospects of the company. Let's explore these notions in depth and their concrete impact on investing in startups.
Defining pre-money and post-money valuation: what they really mean
Pre-money valuation: the current value of the startup
The pre-money valuation represents the estimated value of the startup before any new capital contribution. It is calculated by taking into account multiple factors such as:
Existing assets (patents, technology, intellectual property).
Commercial traction (current revenue, recurring customers, etc.).
Market potential and growth projections.
The founding team and its history of success.
Post-money valuation: the impact of investment
The post-money valuation includes the investment made. It can be calculated as follows: Post-money valuation = Pre-money valuation + Amount invested
Example: If an investor injects €1 million into a startup valued at €5 million pre-money, his post-money valuation becomes €6 million.
How these notions influence your investor shares
The percentage of shares that an investor owns depends directly on the post-money valuation. Here is the key formula: Investor shares (%) = Investment amount / Post-money valuation
Detailed example:
Pre-money valuation: €5 million
Investment: €1 million
Post-money valuation: €6 million
Investor's shares = 1,000,000 / 6,000,000 = 16.67%
This means that the investor becomes the owner of 16.67% of the company after the fundraising.
Why is it essential?
Anticipated dilution: With each new round of fundraising, the share of initial investors decreases. Anticipating these effects is crucial to protect your interests.
Governance: Investors, especially business angels, often play an active role in the strategy of startups. Meaningful participation provides access to important governance rights.
Voting rights : Investors can influence strategic decisions, such as fundraising or governance changes.
Strategy Committee : Beyond voting rights, a significant investor can request a seat on the strategic committee to ensure better oversight of the company's performance.
Calculated return: Valuation has a direct impact on the potential return for investors, whether through dividends or during an exit.
Dividends : Although rare in growth-stage startups, dividends can represent a source of income for investors in the medium to long term. A realistic valuation ensures that profits are redistributed fairly according to the share of capital held.
Exit : Exit is a key moment when investors recoup their gains via a resale or an IPO. An excessive pre-money valuation can limit the potential return on an exit if the startup is sold at a lower value than initially estimated.
Compliance with the thresholds for tax advantages in an SPV: An SPV (Special Purpose Vehicle) is a structure often used to bring together several investors. Tax schemes, such as the Madelin IR-PME fund or the PEA-PME, impose participation thresholds to benefit from their advantages.
Madelin IR-PME Fund : A tax reduction equivalent to 25% of the amount invested is possible, provided that specific criteria are met, such as a minimum stake in the capital.
PEA-PME : To take advantage of the tax advantages of the PEA-PME, the shares must be held in an eligible company (SMEs meeting size and turnover thresholds).
Practical subtleties: how these concepts influence negotiations
Pre-money negotiation: a key step
Pre-money valuation is often a key point for founders and investors. Here's why:
Too high pre-money: It can overvalue the startup, increasing the risks for investors
Problems with overvaluation : A pre-money valuation that is too high can make subsequent fundraising complex. In the event of a need for additional financing, if the performance does not justify this initial assessment, this can lead to a downround. This type of situation negatively affects investor confidence and greatly dilutes founders.
Impact on profitability : For investors, an entry price that is too high reduces the potential for return on investment, even if successful.
Case in point : A startup valued at €10 million pre-money but generating little revenue risks losing investment opportunities to competitors with more realistic valuations.
Too low pre-money: It greatly dilutes the founders, which can harm their control in the long term
Risk of demotivation : A strong dilution of founders can harm their engagement and their ability to attract key talent via options such as BSPCEs.
Loss of strategic control : With too little share of capital, founders can lose decision-making power, making operational management and strategic directions more difficult.
Finding balance : A good valuation must balance the financial needs of the startup and the preservation of the founders' interest, to guarantee stable governance
Tip: A balanced valuation reflects the reality of the market, but also the growth potential.
Impact on investment conditions
The notions of pre-money and post-money influence other essential aspects of investing, such as:
Protection clauses: For example, anti-dilution clauses protect investors in the event of future raising at a lower valuation (downround).
Preferential rights: A well-negotiated valuation can include liquidation or governance rights, strengthening the position of investors.
A global perspective: current valuation trends
In France and around the world
Startup valuations vary depending on their industry, stage of maturity, and target market.
In 2023, AI or deeptech startups often have higher pre-money valuations due to their high disruptive potential.
Common mistakes investors make
Overpaying a startup based solely on a fashion or a media one-upmanship.
Underestimating the importance of dilution on future lifts.
Ignoring fundamental metrics (revenue, burn rate, addressable market) in favor of a simple "long-term" vision.
The concrete consequences for business angels
For business angel networks like PBA, understanding the concepts of pre-money and post-money allows them to:
Select the right deals: Invest in startups where the valuation is aligned with the reality of the market.
Protect investors: By ensuring that conditions are favourable for network members.
Supporting founders: Teaching them how to structure balanced fundraising to preserve their capital while attracting investors.
Case study: The consequences of overvaluation
Practical examples of overvaluation and its impacts
For example, a startup valued at €5 million in pre-money during an initial fundraising must quickly raise new funds following an unanticipated cash flow problem. However, its performance disappointed, and the new valuation fell to €3 million post-money.
Consequences:
Increased dilution: Initial investors see their shares heavily diluted, reducing their potential return.
Loss of credibility: The confidence of investors and business partners is weakened, affecting the attractiveness of the company in the long term.
Impact on governance: Founders, having already lost a significant part of their capital, can be even more marginalized after a new fundraising.
Lessons learned:
Anticipation: A realistic valuation based on solid fundamentals (earnings, traction, burn rate) protects against such situations.
Flexibility: Provision for a valuation that leaves room for future financing, while minimizing the risk of over-dilution.
Setting the stage for informed investment
Pre-money and post-money valuation is not just a simple financial calculation: it plays a key role in the structure and success of an investment. A realistic valuation ensures balanced relationships between founders and investors, while laying the foundation for a healthy and sustainable collaboration.
For investors, mastering these concepts allows them to identify solid opportunities, protect their interests in future fundraising and optimize their chances of return on investment. As for entrepreneurs, good valuation management promotes investor confidence while preserving their long-term commitment and also keeps founders motivated.
By understanding these intricacies, you'll be better equipped to navigate the complex yet exciting world of startup investing.
