Pre-Money Valuation

When a young company raises fresh money from investors, one figure has to be established first: What is the company actually worth? This figure is called the pre-money valuation, meaning the value before the money is paid in. If you add the new money on top, you get the post-money valuation, the value after the money is paid in. Example: A company is valued at 20 million euros, and an investor pays in 5 million. Then it’s 20 million before, 25 million after, and the new investor owns 5 out of 25 million, meaning 20 percent of the company. This figure is not a measured quantity, but the result of a negotiation.

What hinges on the number before the money

The pre-money valuation determines how much of the company the founders have to give up for their money. At a valuation of 20 million, an investment of 5 million costs 20 percent of the company. If the valuation is only 10 million, the same investment already costs a third. So for the founders it’s about a great deal of ownership, while for the investor it’s about their later profit.

That’s why hardly any other figure in a financing round is fought over as hard. Investors want a low valuation, founders want a high one. But too high a value can come back to bite you later. If the next round takes place at a lower price, this is called a down round. This strongly dilutes the founders' shares and is considered a bad signal in the industry.

For outsiders, the valuation is also a mood gauge. If pre-money valuations rise quickly across an entire industry, that points to plenty of available capital and high expectations. That is exactly what could be observed among AI startups in the years after 2022.

How the number emerges in negotiation

For established companies, a value is calculated from profits and revenues. Young technology companies often don’t make any profit at all yet. So people work with comparisons: What did investors recently pay for similar companies? On top of that come factors such as growth rate, market size, quality of the team, and how easily competitors could copy the product.

But supply and demand have the strongest effect. If three funds want to invest at the same time, the price rises. If there is only one interested party, that party sets the terms. The valuation is thus less a calculation than a price, much like at an auction.

A common misconception is to confuse the valuation with actual money. A valuation of one billion doesn’t mean that someone would pay that sum for the company. It is derived from a small stake that a single investor bought, which is then extrapolated to the whole. The company might never actually be sellable at that price.

Pre-money in startup news and cap tables

In reports about financing rounds, the term is almost always implied rather than stated. If it says an AI startup raised 100 million dollars at a valuation of 2 billion, that usually refers to the post-money valuation. The pre-money valuation was then 1.9 billion. Anyone who confuses the two calculates the shares incorrectly.

The figure becomes practically relevant in the so-called cap table, a table listing all owners and their percentage stakes. Every new round changes this table. Employees notice this too, since many startups pay part of the salary in stock options, whose value is directly tied to the valuation.

The term also comes up with the word unicorn, referring to companies with a valuation above one billion dollars. Such titles are based on exactly these negotiated figures. They say something about investors' expectations, but only little about revenue or profit.