Understanding how pre-money and post-money valuations differ

There are several terms you should know when you’re seeking funding for your business, but "pre-money" and "post-money” are by far the most important. You will likely hear these terms many times during a venture capital investment round, whether it’s regarding a capitalization table or term sheet. Understanding pre- and post-money is important because they relate to the valuation and funding of your firm.

 

Pre-money, defined

Post-money, defined

Pre-money versus post-money in action

Related financing terms to know

1. Common Stock:

   Also known as voting shares or ordinary shares, is a kind of equity ownership that represents owning a piece of a firm. It's a form of stock that provides you a portion of a company's ownership and voting rights at shareholder meetings. The quantity of ownership is the difference between how much common stock a person owns and how much was issued.

2. Preferred Stock:

   A type of equity with debt characteristics. Preferred shareholders, like regular stockholders, receive a share of an organization's ownership. They also have specific rights, such as guaranteed dividends that must be paid before common shareholders' payouts and priority in the event of liquidation. Preferred stock is traded at a different price than ordinary stock and is listed separately from common stock.

3. Liquidation Preference

   : A type of preferred stock issued to investors. Preferred stock is typically provided to venture investors as equity. When a firm is bought out or goes bankrupt, liquidation preference gives investors priority for compensation. After the shareholders have received their portion, preferred stockholders are the next to benefit from the company's liquidation. Note that there are three types of liquidation preference:
   
   Straight or nonparticipating: Generally the best option for a business. Preferred stockholders can either recover their initial investments plus accumulated dividends if the company is liquidated, or they can convert their shares into ordinary stock and be regarded as common stockholders if the company is liquidated. Remaining funds are distributed to common shareholders.
   
   Participating in the process: Usually advantageous to investors. The investor receives their investment plus any accrued dividends. The investor is also treated like a common stockholder and is generally paid twice.
   
   Capped or partially participating: Confers all the benefits of a participating preference, except the investor's money is capped. When an investor has attained the capped amount, they are typically unable to accept any more.

4. Convertible note

   : A form of debt that, rather than being used as a typical loan repaid with interest, changes into equity in exchange for an investment.

5. Round size

   : The amount of money a firm gets from a round of financing. When entering into an investment round, it's critical to consider more than just the round size. It’s also crucial to think about the terms of the loan, such as the overall amount of equity being given up.

6. Option pool

   : The number of shares set aside for future workers and investors. It's the proportion of a firm that the owner is willing to give away in the future.