Pre-Money ValuationHow to Calculate It

By Karl M Sjogren

Blogger/Author The Fairshare Model www.fairsharemodel.comkarl@fairsharemodel.com

Video Presentation on YouTubehttps://lnkd.in/bN467cr

What is the Valuation of a Company? The price to buy the entire company (i.e., Microsoft will buy LinkedIn for $26

billion).

If “100% of the company is offered for $1 million,” it’s the valuation for the acquirer.

Valuation is not-so-obvious when a fractional interest is sold; investors calculate valuation differently. To an investor, $1 million is the valuation if:50% is offered for $1 million66% is offered for $2 million 33% is offered for $0.5 million

I will show you how to make sense of this and how to calculate the valuation from an investor’s perspective!

Value vs. Worth “Valuation” is a slippery word…its meaning is context sensitive.

A company’s valuation is it’s price, not it’s worth.

A company’s market value reflects the most recent price for a piece or share of it.

If someone says a company is overvalued, they mean it is overpriced.

If they say a company is undervalued, they mean it is underpriced (a bargain).

Valuation experts use valuation to mean what they think a company may beworth…considering evidence of both worth and market value.

What is “Worth?” We sense worth for what we derive utility from (home, clothing, food). We sense if a house is worth $1 million, a pair of pants is worth $60 or a sandwich is

worth $5.

We struggle to sense worth in investments—art or securities. That’s because they lack utility.

Nonetheless, valuation is important if you want an attractive return on an investment.

Determinants of a return on investment:Price paid (buy-in valuation)Price received (exit valuation) Length of time investment held

Our focus

Pre-Money vs Post-Money Valuation Another reason “valuation” is a slippery term: There is a “pre-money valuation” and “post-money valuation”

And which one is important depends on the context, which the next table will explain.

Which Valuation is Important When?Private Company Public Company

Pre-MoneyValuation

Post-Money Valuation

Important for an IPO—the initial price setting in the public market.

Moot point for a secondary offering—it generally is the market price.

Interesting but unimportant; no secondary market.

Important

Important—it is the market capitalization.

What is important—pre-money valuation of next round of capital.

Pre-Money Valuation- Simplified

It depends on “when”—before or after you put $20 in the pocket. If the pants are worth $20 (fairly priced) before your $20, it is now worth $40

Imagine you are checking out a pair of pants offered for sale for $20. You put $20 in the pocket. What is the value of the pants?

Price of the pants $ 20Money you put in the pants pocket 20Value of the pants with your money $ 40

Overpriced$ 15

20$ 35

Underpriced$ 30

20$ 50

But…if worth $30 to begin with (underpriced), the pants are now worth $50

On the other hand, if only worth $15 (overpriced), they are now worth $35

Why is Pre-Money the Key Figure?

Price of the pants $ 20Money you put in the pants pocket 20Value of the pants with your money $ 40

Equivalent for a company

Pre-money valuationThe OfferingPost-money valuation

Pre-money is the price before the offering (i.e., new money).

Relevant question is the asset—pants or company—worth the price before the offering (i.e., before the new money is added)?

Two Ways to Calculate Valuation1. Shares Outstanding Method

Number of shares outstanding before the offering

Number of new shares offered

Price of a new share

2. Percentage of Ownership Method Total amount of money to be raised in offering

Percentage of company to be sold in offering

What is known determines the method to use

Share Method Calculation

Pre-Money Valuation Number of Shares Outstanding Before the Investment

= X Price of a New Share

Example : ABC Company has 10 million shares outstanding and plans to raise $5 million. It offers 1 million new shares at $5 per share. So, it’s pre-money valuation is $50 million.

$50 million = 10 million shares X $5 per share

The relationship between the pre- and post-money valuation:$ 50 million Pre-money valuation ( 10 million shares X $5 per share)+ 5 million Money raised (1 million shares X $5 per share)-----------------$ 55 million Post-money valuation (11 million shares X $5 per share)

Percentage Method Calculation (1 of 3)This calculation takes a few steps that we’ll follow in a new example. ◦ Let’s say another company, XYZ, seeks to raise $10 million in exchange for 10% of

the company.

◦ What is the pre-money valuation of XYZ Company?

The relationship between money and valuation can be expressed as either:

1. Pre-money valuation + Money = Post-money valuation

2. Post-money valuation – Money = Pre-money valuation

3. Pre-money valuation = Post-money valuation – Money

Pre-money valuation is in bold as a reminder that its the figure we’re interested in.

The next slide references this

The Percentage Formula (2 of 3)The formula to calculate pre-money valuation using the percentage method:

Pre-Money Valuation

= - Investment Amount

Investment Amount

Percentage of the Company for SaleThe Post-Money Valuation

Investment Amount

Percentage of the Company for Sale

And that,

The formula boils down to this:◦ Pre-money valuation = Post-money valuation - Money

=

When you recognize that

Investment Amount=The Money

Apply the Percentage Formula (3 of 3)So, let’s figure out XYZ’s pre-money valuation if $10 million buys 10% of the company.

$10,000,000 investment

0.10 (10% of XYZ)= $100,000,000 XYZ’s post-money valuation

$100,000,000 XYZ’s post-money valuation

=- $10,000,000 Money XYZ seeks to raise

$90,000,000 XYZ’s pre-money valuation

Table presentation

XYZ Company Valuation Pre-Money Valuation $ 90 millionMoney (the Offering) 10 millionPost-Money Valuation $ 100 million

Proof

Ownership90%10%

100%

Percentage Calculation Not IntuitiveUnless you are a math whiz, you’ll need a calculator to compute valuation using the percentage method.

If you think you can eyeball it, be careful.

If $10 million buys 100% of the company, it’s pre-money valuation is zero.

If $10 million buys 50%, the pre-money valuation is $10 million

If $10 million buys 1% of the company, it’s pre-money valuation is $990 million

Because Valuation is Non-Linear

Handy rule: If half the company if for sale, the pre-money valuation is the amount of the offering.

Other amounts are not intuitive.

Valuation changes in a non-linear manner as the percentage of the company purchased changes.

Things that Cloud a Valuation

The right to acquire stock in the future at a lower price than new investors can cloud the significance of a pre-money valuation.

Restricted Stock

Stock Options or Warrants

Convertible Debt

Examples:◦ Restricted stock

Multi-Class Capital Structure

◦ Stock options and warrants

◦ Convertible Debt

◦ Multi-class capital structure—because such a structure enables special terms

Terms Can Ecilpse a ValuationSpecial terms granted to some investors can make a pre-money valuation somewhat meaningless for other investors.

Price protection◦ Price Ratchet provides a retroactive price

reduction if later investors get a lower valuation.

Preferential return◦ Liquidation Preference: enables an

investor to get a multiple (e.g., 2X) of investment back before others get anything at all.

Redemption Right◦ Obligates company to buy back

shares.

VCs rely more on getting the right terms than getting the pre-money valuation right.

◦ Because it is hard to reliably figure out what a company is worth.

A company must have a multi-class capital structure to grant special terms.

◦ Single-class: All for one and one for all

◦ Multi-class: All investors are shareholders, but some shareholders are more equal than others

Multi-class capital structures are common in private companies that have VC/PE investors; far less common in public companies.

Want More Food for Thought?Check out The Fairshare Model, the book I’m writing.

Its about a performance-based capital structure for companies that raise venture capital via a public offering.

I call it the Fairshare Model because it balances and aligns the interests of investors and employees

Target Audience: anyone who might want to invest in or work for a venture-stage company…or has interest in economics, philosophy or organizational structure

Preview it: visit www.Inkshares.com and search for “Fairshare Model”

Fairshare Model: a crowd-vetted book

Section I – Overview

Chap. 1 – The Fairshare Model

Chap. 2 – Orientation

Chap. 3 – Brief Q&A

Chap. 4 – The Problem With a Conventional Capital Structure

Chap. 5 – Crowdfunding

Chap. 6 – Target Companies

Chap. 7 – Fairshare Model History & Projection

Section II – Macro Context

Chap. 8 – Economic Growth

Chap. 9 – Income Inequality

Chap. 10 – Cooperation as a Tool for Competition

Chap. 11 – Tao of the Fairshare Model

Section IV – Fraud, Failure & Other Objections

Chap. 16 – Three Causes of Investor Loss: Fraud, Overvaluation & Failure

Chap. 17 – Failure

Chap. 18 – Other Objections to Public Venture Capital

TBD – Secondary Markets, Accounting Issues, Game Theory, Behavioral Finance and wrap-up

Full draft at www.fairsharemodel.com

Section III – Valuation

Chap. 12 – Concepts

Chap. 13 – Calculation

Chap. 14 – Evaluation

Chap. 15 – Disclosure

Pre-Order Bonus: Special version of chapter 13; it has tables to look-up a pre-money valuation based on % of company sold.

When you pre-order The Fairshare Model you get a bonus!

Pre-Money Valuation Table Bonus

Benefits of the table:• Pre-money valuation without calculation• Makes “what-if” scenarios easier• Better perspective on valuation

How it works:• Find column with offering size• Find row with % of ownership offered• Intersection is pre-money valuation

Range: offerings from $0.5 to $26 million, in $0.5 million increments

If a company offers X% of its equity for an investment of $Y, what is the pre-money valuation?

Fairshare Model Pre-Order Benefits 1. Discounted price on e-book or an e-book/print combo.

2. Print copies are signed!

3. Bonus: Valuation Calculation chapter with Pre-Money Valuation Tables.

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◦ Performance-based capital structures are not new—many private offerings use one. But their use in an IPO is revolutionary!

How to Pre-Order the Fairshare ModelVisit www.Inkshares.com and search for “Fairshare Model”

◦ Direct link https://www.inkshares.com/projects/the-fairshare-model◦ Or, visit www.fairsharemodel.com and follow the link to Inkshares

The Fairshare Model will be published about five months after 250 pre-orders are received. If the goal is not met, your money will be refunded.

Thanks for watching!