28 Jun 2019, 17:00 — 5 min read
Background: The valuation of a company is measured in terms of its pre-money and post-money. Both these parameters are crucial in determining how much a company is worth. Pre-money is basically a measure of how much a startup is worth before it receives any funding from investors and post-money is the worth of a company after it receives money and investments. Anisha Patnaik in her previous article explained whether or not you can grant ESOPs to the co-founder of a company. In this article she shares the strategy behind the valuation game of companies.
In this article, we will be explaining the concepts of investment amount and valuations. The most basic of all concepts in an investment process – if you get these basics right then the rest of the process may become relatively easier (not necessarily painless!)
Most investors / VCs and entrepreneurs start the investment game / conversation with a statement that goes something like this:
Entrepreneur: I am seeking a $1m investment in exchange for a 20% equity stake in my company.
Investors: We typically invest $2m (or our 'sweet spot' is $2m) and we take a minority stake in the startup – typically in the mid to high-teens
The investment game
Let us break down the terms in the figure:
The ownership% is the investment amount over the post-money valuation, also referred to as dilution, i.e. we don’t want to give away more than 20% of our company.
So, what comes first? pre-money, new money, post money or ownership%?
It is the new money!
Once the money is in – it is old money. So, now when a new investment comes in the old investor’s share gets the same dilution as the promoter shares. Take a few minutes and work through this next round of investment – $5M new-money for a $25M post-money.
Also read: Money does not motivate people, this does!
That jump in valuation is what each investor is looking for when they invest into their company with an expectation of what the eventual return would be for them and when. All the investment terms that go alongside the valuation and ownership are linked to the differences in yours and their expectations or around the risks of ensuring some minimum returns.
So, how much equity should an investor get for funding a business?Exactly what his investment amount will buy him over the post-money valuation that you agree to create using the funding (investment amount)!
Also read: How SMEs can succeed in a digital world
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Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views, official policy or position of GlobalLinker.
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