| When a company decides that it must raise capital, a | | | | can be a disagreement. The investor may have |
| key question that must be answered is how much | | | | thought that equity in the company was worth |
| the company is worth. For example, if the business | | | | $1,000 per percentage point, in which case $250,000 |
| needs $500,000 to get started and/or grow, how | | | | gets 250 out of 1,000 shares or a 25% equity |
| much of the equity in that company should $500,000 | | | | position. Conversely, the company may have believed |
| command? Once this question is answered, the | | | | that the investor was contributing to the enterprise |
| company will go out and try to find investors. When | | | | which was already worth $1 million. Under this |
| doing so, a key question often arises as to whether | | | | rationale, the $250,000 would give the investor 250 |
| the valuation is "pre-money" or "post-money." | | | | shares out of 1,250 shares or a 20% equity position. |
| "Before the money" or "pre-money" and "after the | | | | The critical issue was whether the agreed value of $1 |
| money" or "post-money" denote simple concepts. | | | | million to be assigned to the company was prior to or |
| However, these simple concepts can even confuse | | | | after the investor's contribution of cash (pre-money) |
| even the most sophisticated analysts at times. If a | | | | or post-money. |
| company is valued at $1 million on Day 1, then 25 | | | | In the above case, a pre-money valuation of $1 |
| percent of the company is worth $250,000. | | | | million and a post-money valuation of $1.25 million |
| However, there may be an ambiguity. Suppose the | | | | were equivalent. Because mixing up the terms could |
| company and the investor agree on two terms: (1) a | | | | significantly increase the cost of capital raised, |
| $1 million valuation, and (2) a $250,000 equity | | | | companies must be sure to understand the two |
| investment. In this case, the company may offer the | | | | metrics and agree with investors to the metric that |
| investor 250 shares for $250,000. Immediately there | | | | raises them the capital at the appropriate price. |