Third, the “pre-money” vs. “post-money” confusion
Angels speaking in terms of “pre-money valuations” can lead to some confusion. Entrepreneurs often think in terms of “share of the company sold” and the cost of that stake in the company. So, for example, they might say “we are selling 25% of the company for $500,000.”
Multiplying each side by four: 25% of the company => 100% of the company; $500,000=> $2 million. So my valuation is $2 million.
This math is right, but that is not the pre-money valuation. It’s the valuation of the company including the investment that has been made – because the shares are purchased and the money goes into the company. So once we’ve invested, the post-money valuation is $2 million in this scenario.
To get the pre-money valuation, we have to subtract “the money” – i.e. $500,000 from $2 million. In angel language, this is a deal with a $1.5 million (pre-money) valuation.
Got it? Good – because this mistake appears quite a lot.
Consider this TechCrunch article from early March: on Dragons’ Den (Shark Tank with posher accents) M14 industries negotiated “a deal £80,000 for 20 percent equity, giving the young startup a £400,000 pre-money valuation.” No it didn’t.
Or a pitch we recently saw from an otherwise compelling company: “raising $350k for 10% equity, a $3.5M pre-money valuation.” No it isn’t.