9-802-179

REV: APRIL 16, 2002

LINDA A. CYR

A Note on Pre-Money and

Post-Money Valuation (A)
The topic of pre-money and post-money valuation regularly surfaces in discussions of
entrepreneurial ventures. An important topic to understand, it is the vocabulary most often used in
negotiations with angels, venture capitalists and the like. The purpose of this note is to introduce the
concept of pre-money and post-money valuations as implied valuations by first discussing their
relationship to target returns expected by investors and then by illustrating that pre and post-money
valuations can be calculated in a variety of ways depending on the information provided.

Implied Valuations and Relationship to Target Returns

First, it is important to understand that pre-money and post-money valuations are calculated only
as the result of a financing event. They are implied valuations in the sense that they are not “bottom
up” estimates of the firm’s worth. In this sense, an implied valuation is the answer to the question
“what must the investor think the company is worth (at a minimum) if she is willing to buy X% for
$Y?” Thus, the valuations that we impute or infer from financing events are quite different from
valuations derived in Finance whereby the valuations are the result of much analysis and are used as
inputs to decisions related to purchasing all or part of the enterprise. For most nascent ventures, the
annual future cash flows upon which discounted cash flow (DCF) analyses might be based are so
uncertain as to make the conclusions speculative at best.

So how is it that venture capitalists and other investors arrive at estimates of the underlying value
of new ventures before they write their checks? In addition to their having extensive experience that
gives them an understanding of what the valuation should be based on an assessment of the
opportunity, quality of the entrepreneurial team and stage of the venture, investors commonly “back
into” pre-money and post-money valuations by first considering their targeted returns on
investment.

Imagine that a venture capitalist is considering investing $4 million in an early stage venture and
she desires a 50% return on her money over five years. Venture capitalists and other investors
usually have an understanding (or at least an expectation) of what the “market” looks like in terms of
________________________________________________________________________________________________________________
This case derives from an earlier case, “Pre-Money and Post-Money Valuation,” HBS No. 801-446, also prepared by Professor Linda A. Cyr. HBS
cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or
illustrations of effective or ineffective management.

Copyright © 2002 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be
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 802-179 A Note on Pre-Money and Post-Money Valuation (A)

years to exit and possible multiples of revenue, profit or cash flow that are appropriate in
determining exit valuations for start-up firms. In this case, our venture capitalist knows that ventures
of this type tend to go public or be sold at valuations in the range of five times revenue by the fifth
year. Given the entrepreneur’s revenue plan and the VC’s own evaluation of the probability of
th
hitting the plan, the VC expects that the venture will be valued at $150 million (5 times 5 year
revenue of $30 million) in five years. She also knows that her portion of the terminal value in order
5
to reap a 50% return on her $4 million must be $30 million ($30M = $4M x 1.5 ). In order to have a
claim on $30 million, she must own $30/$150 or 20%. We will see in the next section that if the VC is
investing $4 million and must own 20% of the firm’s equity, this places an implied post-money
valuation on the firm of $20 million with a pre-money of $16 million.1

We can see from this example that pre-money and post-money valuations are directly related to
the investor’s target return on her investment. If the VC in the above scenario were to raise her
5
targeted return to 75%, she would have to buy almost 44% of the equity for $4 million ($4M x 1.75 =
$66M and $66/$150 = 44%). This effectively lowers the maximum price she should be willing to pay
to achieve her targeted return and makes the capital more expensive for the entrepreneur (i.e. lowers
the valuation). Alternatively, if her targeted return were lower – say 25% - the required value of her
5
ownership claim at exit would be only $12.2 million ($4M x 1.25 = $12.2M) or 8.1% ($12.2/$150 =
8.1%). Thus, if the investor’s targeted return is lower, the entrepreneur is able to raise his $4 million
at a higher valuation by giving up less of his equity. Note that equity purchased at a high valuation
is better for the entrepreneur and worse for the investor in the sense that, at a relatively high
valuation, a given amount of capital purchases a relatively lower percentage stake in the company.

Thus, the investor’s perspective on pre-money or post-money valuation is the mathematical result
of determining what she is willing to pay for a given ownership stake while still earning an attractive
return. From the entrepreneur’s perspective, pre and post-money valuations are based on the
minimum amount of capital he is willing to accept in exchange for a given amount of equity. The
final pre and post-money valuations will be the result of a negotiated agreement between the investor
and the entrepreneur in which the investor will attempt to pay less than her reservation price and the
entrepreneur will attempt to accept no less than his reservation price.2

Calculating Pre-Money and Post-Money Valuations

As previously stated, pre-money and post-money valuations are calculated only at the time of a
financing event. They are the mathematical result of an investment decision.

Simply defined:
Pre-money valuation is equal to the price paid per share in the financing round multiplied
by the number of shares outstanding before the financing event, and

Post-money valuation is equal to the price paid per share in the financing round times the
number of shares outstanding after the financing event.

1 This assumes only one round of financing. Multiple rounds and dilution will be illustrated later in the note.

2 The reservation price for the investor represents the maximum price (i.e. valuation) she is willing to pay for a given level of
equity, and the reservation price for the entrepreneur represents the minimum price (i.e. valuation) he is willing to accept for a
given level of equity.

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 A Note on Pre-Money and Post-Money Valuation (A) 802-179

However, many of the references that we hear about pre and post-money valuations make no
mention of shares outstanding. Instead, entrepreneurs and investors (and reporters) speak in terms
of cash infusions and equity stakes offered in return. For example, one could find an article in the
Wall Street Journal (September 1999, “Motley Fool Lines up Infusion of Capital”) that describes a
closely-held company’s lining up $26.5 million in venture capital. Although specific terms were not
disclosed, the article stated that “people familiar with the financing say the new investors are
acquiring slightly less than a 15% stake. That would value the entire company at about $200 million.”

We can assume that the $200 million to which the article refers is the post-money valuation—that
is after the $26.5 is included. Actually doing the math ($26.5/$200) indicates that for the post-money
valuation to have been $200 million, the VCs would have had to agree to own only 13.25% for their
$26.5 million—an amount that seems to stretch the phrase “slightly less than 15%.” In fact, if the VC
put in $26.5 million for 15% as the article states, the post-money valuation would only be $176.7
million. Perhaps Motley Fool and the WSJ reporter were taking some liberty in rounding up the
value?

If the real post-money valuation was $176.6 million, then what was the pre-money valuation?
Since the value of a “fresh” $1 invested is precisely $1, then the pre-money valuation was $176.6
million minus $26.5 million, or $150.1 million. Given the “naturalness” of a $150 million pre-money
valuation, that is likely to have been the basis on which the deal was negotiated and the small
differences likely have to do with rounding the price per share to an easily calculated number.3

Two Cases: Vermeer Technologies and TallyUp

Let’s take a look at two examples from cases that we have covered in The Entrepreneurial Manager4
to illustrate the different methods of calculating pre and post-money valuations. We will begin with
a simple case of the financing of Vermeer Technologies (HBS Case 397-078) in which we are given no
information regarding share prices or number of shares outstanding. Second, we will examine the
case of TallyUp, a portfolio firm of ONSET Ventures (HBS Case 898-154) in which we were provided
with shares outstanding at each financing round.

Vermeer Technologies
In the Vermeer (A) case (p. 7), we were told that the Sigma-Matrix-Atlas syndicate was willing to
infuse $4 million in capital in exchange for 51% of Vermeer’s stock. Thus, by dividing the $4M by
51% we conclude that the VC syndicate believed that Vermeer was worth $7.8M after the $4M
investment. Again, by simple subtraction, we find that the pre-money valuation for Vermeer was
$3.8M. It is often simplest to think of this in terms of cells within an Excel spreadsheet. The bolded
cells are those that we must calculate and the non-bolded cells are those provided in the case.

3 Thanks to Felda Hardymon for this insight into how press releases get written and how one might tease out what actually
happened.
4 The Entrepreneurial Manager is a required course at Harvard Business School.

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 802-179 A Note on Pre-Money and Post-Money Valuation (A)

Financing % Bought in
Event Pre Money Cash Infusion Post Money Round Step Up Venture Capitalists

Jan-95 3,843,137 4,000,000 7,843,137 51.00% Sigma-Matrix-Atlas

Oct-95 32,000,000 7,200,000 39,200,000 18.37% 308% Menlo Ventures

So where did the $3.8M of value come from? One might argue that there was value in the idea or
in the development team that Ferguson had assembled (i.e. Forgaard and nine employees working
for equity). However, there would have been little (or no) value without the investment from the
venture capitalists (or some other investor). That is, without a capital infusion, Vermeer would not
have had the resources necessary to pursue the idea and therefore would not have been able to create
any value at all.

What about the second round of financing? The Vermeer (C) case (p. 1) states that “Vermeer had
negotiated with a team of VCs, with Menlo Ventures as the major investor, for second round
financing of $7.2 million against a pre-money valuation of $32 million.” Thus, the post-money
valuation is the $7.2 million plus $32 million => $39.2 million. We can also conclude that the new
investors acquired 18.37% of the company ($7.2/$39.2M) in this round.

A couple of related questions are in order at this point. For example, how is it that the $32 million
pre-money valuation does not match the $7.8 million post-money valuation from the prior round?
From where did the additional value come? The objective is always to use $1 to create more than $1 of
value. If the company is successful at creating more than a dollar of value for every dollar invested,
the pre-money valuation in the next round will be higher than the post-money valuation from the
prior round. The benefit to the firm’s stockholders is that the company can raise a given amount of
funds by selling less of the company; the existing shareholders suffer less dilution as a function of the
higher valuation upon which the funds are raised.

It can be argued that Vermeer was able to create value in the nine months between January 1995
and October 1995 by: (1) designing a working end-to-end product demo, (2) establishing numerous
beta sites to detect bugs in the software, (3) establishing relationships with high profile companies
that might be potential partners and customers, (4) getting mainstream press coverage, and (5)
shipping FrontPage 1.0. Given the progress that the company has made, it is reasonable to assume
that the company might be worth more than the $7.8M post-money valuation from nine months
prior. However, Vermeer was able to achieve a pre-money valuation of $32 million only to the extent
that it was able to find investors who were willing to provide additional funds at a rate consistent
with that valuation. Vermeer was able to find investors who were willing to accept 18% of the
company in exchange for $7.2 million again highlighting the importance of the financing event to
calculating the pre-money and post-money valuations.

TallyUp
Let’s turn our attention to the case of TallyUp, a compensation software company that has been
“in incubation” under the sponsorship of ONSET Ventures. Please see Exhibit 1 - ONSET
Capitalization Table. Note that the TallyUp example is a bit more comprehensive than the Vermeer
example, in that we are provided share information. It illustrates the (somewhat comforting) fact that
we can arrive at the same result using two different methods.

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 A Note on Pre-Money and Post-Money Valuation (A) 802-179

Page 10 of the ONSET case states that “ONSET invested $750,000 to purchase preferred shares (at
$1 each), in return for 31.5%, based on a $2,375,000 post-money valuation.” Simple calculation (cash
infusion of $750K divided by post-money of $2,375K) indicates that ONSET purchased 31.58% (31.5%
in the case) of TallyUp. Given the price per share of $1, we can also conclude that there are 2,375K
shares outstanding after the financing and therefore 1,625K shares outstanding before the financing
(750K shares). The 1,625,000 shares outstanding before the financing are Founders’ Shares.

Page 13 indicates that upon hiring the CEO, ONSET invested the additional $250K on the same
terms (i.e. $1 per share, raising the post-money valuation to $2,625,000) in accordance with its earlier
agreement. The calculation indicates that ONSET purchased 9.52% of TallyUp in this “round.” Note
that the percentages purchased in each round are not additive; ONSET’s cumulative stake in TallyUp
after its two rounds is 38.1%. The 38.1% stake is equal to the $1 million ONSET has invested divided
by the $2.625 million post-money valuation or alternatively, ONSET’s 1 million shares divided by the
2.625 million total shares outstanding after the $250K infusion.

One must also account for the option pool of 750,000 shares ($1 per share) mentioned on page 14.
This is a little more complicated and admittedly tougher to understand, but let’s try to work it out. In
fact, these shares have not actually been issued, but have been set in reserve for future issuance. Why
then, are we depicting the shares as if they have been issued? Primarily because doing so allows us
to examine the potential effect of the options on ONSET’s holdings.

The decision to show the options as if they have been issued is based on two underlying
assumptions. First, it is not unreasonable to assume that the options will be exercised at some point
in the future. After all, ONSET and TallyUp have the expectation that the value of TallyUp’s shares
will continue to rise and that TallyUp will achieve liquidity of its shares (i.e. IPO or acquisition) down
the road.

Second, it is safe to assume that at the time of its earlier investments, ONSET anticipated that at
some point in the future TallyUp would issue these options. Thus, TallyUp did not unilaterally (nor
would they be contractually able to) make the decision. ONSET undoubtedly has plenty of
experience (and lawyers) in thinking through the dilutive effects of setting up option pools for future
employees.5

Indeed, we do see that the result of issuing the shares will have a dilutive effect on ONSET’s
holdings. ONSET’s cumulative stake drops from 38.1% to 29.6%. Arguably, as previously
mentioned, ONSET would have anticipated this effect at the point of its investment and the effect is
therefore implicit in the pricing of the previous rounds.

Conclusions
It is essential that any entrepreneur seeking to raise capital have both a conceptual and a
mechanical understanding of pre-money and post-money valuations lest he be at a significant
disadvantage to the potentially more experienced and savvier investor. These valuations can be
thought of as implied valuations that result solely from financing events and are calculated in any
number of ways using the information provided.

5 It is quite common for venture capitalists to require that their portfolio firms set aside option pools for future employees.
Generally, VCs ensure that a large-enough pool is reserved to enable the entrepreneurial firm to hire the kind of employees it
will need to get it to the next stage of funding, at which point the size of pool is reassessed. Typically these pools consist of
about 20% of the outstanding stock, which is consistent with the 22% (750K shares in the pool divided by the 3,375 shares
outstanding after) in the ONSET case.

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 802-179 -6-

Exhibit 1 ONSET Capitalization Table

Founder Round Seed $750K Additional $250K Options

Shares Percent Owned Shares Percent Owned Shares Percent Owned Shares Percent Owned
ONSET 750,000 31.6% 750,000 28.6% 750,000 22.2%
ONSET - 2nd Tranche 250,000 9.5% 250,000 7.4%
Option Pool* 750,000 22.2%
Subtotal 0 0.0% 750,000 31.6% 1,000,000 38.1% 1,750,000 51.9%

ONSET Cumulative Stake 750,000 31.6% 1,000,000 38.1% 1,000,000 29.6%

Founders 1,625,000 100.0% 1,625,000 68.4% 1,625,000 61.9% 1,625,000 48.1%

Total Shares 1,625,000 100.0% 2,375,000 100.0% 2,625,000 100.0% 3,375,000 100.0%

Price Per Share = Cash In / Shares Issued $1.00 $1.00 $1.00

Pre-Money Valuation $1,625,000 $1,625,000 $2,375,000 $2,625,000

Cash Infusion $0 $750,000 $250,000 $0
Post-Money Valuation $1,625,000 $2,375,000 $2,625,000 $3,375,000

* Issue Option Shares with No Cash Infusion and $750K Increase in TallyUp Valuation per p. 14

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