When we value a company, we value its equity (the Market Value of Equity) to determine the price paid for a transaction (acquisition, financing or other) where the investor receives ownership, which is an equity stake. The valuation can take place also for information purposes for debt financing, but it is mostly relevant for equity transactions.
When we talk about startup valuation, we use different terms than we would use in standard valuation, where we refer to Enterprise or Entity Value and Market Value of Equity to indicate the value of a company with or without its net debt (plus other adjustments).
With startup valuations for financing purposes, these terms are rarely used. Also, a startup is unlikely to have net debt or non-operating assets, and therefore the Enterprise Value usually equals its Market Value of Equity.
For startups, you will instead often see the terms post-money valuation and pre-money valuation.
Pre-money valuation refers to the value of the company before the investment. Post-money valuation refers to the value of the company after the equity financing has taken place.
The equity stake is calculated on the post-money valuation, which represents the Market Value of Equity in the traditional sense. The scope of using these terms, particularly the use of the ‘pre-money valuation’ is mainly to calculate the correct portion of shares before and after a transaction with its fully diluted value, which we will see later.
The most basic and simple way to calculate the value of your startup, is to divide the investment needed by the amount of shares (or stake) given away to the investor, to arrive at the post-money valuation. This reveals the underlying or assumed valuation based on the investment that is at the basis of the negotiations:
Subsequently, we can also calculate:
Pre-money valuation = Post-money valuation – Investment
The calculation of ownership is then illustrated as follows:
|Pre-Money Valuation||$ 4 million||80% (existing shareholders diluted by 20%)|
|Investment Amount||$ 1 million||20%|
|Post-money Valuation||$ 5 million||100%|
SHARES AND CAP TABLE CALCULATION
Calculating the number of shares owned at each round, pre- and post-money is slightly more complex.
At each equity round, new shares are issued. The price per share that the venture capital investor is willing to pay is:
Per share price = pre-money valuation / total number of shares outstanding
|Pre-Money share price||$ 4 million|
|Total Number of shares outstanding||4 million|
|Pre-Money share price||$ 1|
The number of new shares to issue is calculated as:
New Shares issued = New Investor Stake x Post-money Total Shares Outstanding
|New Investor Stake||20%|
|Post-money Total Shares outstanding||5 million|
|New shares issued||1 million|
In the same way, we can calculate the post-money valuation as:
Post-money valuation = New Investment x (Total post-investment shares outstanding / Shares issued for new investment)
The total number of shares outstanding is also calculated on a fully-diluted basis in the Cap Table: this means that the total number of shares will include all outstanding common stock plus all outstanding options.
A Cap Table example is displayed below, with investment, pre-money and post-money shares calculated for each round, based on the pre-money share price calculated. TFD is the Total Fully Diluted amount, including ESOP (Employee-Stock-Ownership Plan) and other options not yet realised: the share price will be based on the fully diluted pre-money shares.