Pre-Money Valuation

Pre-money valuation is used mainly in start-up and venture capital financing. It determines how much of the company new investors will own in exchange for their investment.

For example, if a start-up has a pre-money valuation of 16 million and investors put in 4 million, the post-money valuation becomes 20 million. The investors own 4 million divided by 20 million, or 20% of the company, and the existing shareholders keep 80%.

Pre-money valuation is usually the result of negotiation between founders and investors. For young companies with little revenue or profit, it depends on factors such as the strength of the team, the size of the market, early customer traction, the technology, comparable deals and the amount of competition among investors.

Founders generally prefer a higher pre-money valuation, since it means giving up less ownership for the same amount of money. But a valuation that is too high can make future funding rounds difficult if the company cannot grow into it, possibly leading to a down round, where new shares are sold at a lower price.