Understanding Pre-money and Post-money valuations

Introduction

We understand that the bedrock of any asset, physical or intangible, is its value. When startups are considering raising capital, it is essential that the economic value of the business is determined. During the valuation process for the startup, all areas of its business are usually analysed to determine its worth. 

There are two kinds of valuations that are considered before the startup raises capital – pre-money valuation and post-money valuation. The pre-money valuation is the value of the company before funds are raised and the post-money valuation is the value of the company after funds are raised. 

More than 50% of the negotiation between an investor and a startup is based on the agreed pre-money valuation and every side must come to an agreement on this before they proceed with the investment. Pre-money valuation also determines how much equity the investors will own in the startup based on the money they invest. 

Many times, valuations are more of an art than a science. The figure is not a standard calculated amount but determined by factors like the market operated in/market size, competitors etc. As mentioned in the previous edition of this Newsletter, this is a negotiation and an interpretation determined by both parties in the room. For early-stage startups, factors like the team, the product market fit, the product, and strategic partnerships are taken into consideration and for growth-stage startups, the financial projection, market size, team, revenue and profitability stand out more. 

One very standard economic technique used by founders to drive up their valuation at an early stage is demand. When a founder has more investors willing to take a deal, he can use this to his advantage. He would use this power to conclude the best deal, retain more ownership and ultimately increase the valuation of the startup. 

Post-money valuations are easy to understand. They are the pre-money valuation of the company plus the equity received in the company following the funding round.  

In practical terms, this leads to a situation where a startup is valued at $5M after raising $1M with a pre-money valuation of $4M. Consequently, as an early-stage startup moves into its growth phase, its valuation gets higher and previous capital raised plays a big role in valuation. 

Pre-money valuation and Equity stakes 

As mentioned earlier, an important part of pre-money valuations is the investor’s stake in the company. 

When a company is founded, it creates a bucket of shares. with a share is a fraction of the company. The founders of the company, and any initial investors they may have, would be the initial shareholders of the company when it is set up. Subsequently, when the company decides to raise funds, the company would create new classes of shares of the incoming investors. 

Take for example a situation where a company was issued 10M shares at incorporation with two founders, Founder A and B, having 5M shares each. 

The pre-money valuation for the company is $6M and the investor is willing to invest $1,000,000 in the company. 

Thus, it can be said that the startup is raising $1M at a $7M post-money valuation. 

These investors are issued new shares whose factors depend on how much is raised and the equity it is raised for. 

To determine the equity in this case, the founders have 10M shares and 100% equity. With the company has raised $1M at a $7M post-valuation, the percentage of the equity to be given to the investors would be computed as the investment divided by post-money valuation. In other words, the amount invested must equal post money x equity stake (%)

This would be reflected as $1,000,000 ÷ $7,000,000 x 100/1 = 14.28% 

Now, the investors have 14.28% and the founders no longer have 100% equity but 85.72% equity among themselves.

Ideally post money valuation is pre-money plus investment raised but to determine every component of this calculation, there is another formula. 

Post money valuation = Capital raised divided by equity stakes (%) x shares issued. 

As a simple calculation, this formula can be used to determine each piece depending on what figures are known or unknown. It can be used to determine each chunk according to what is available. 

For our above example, the new shares issued approximately 10,000 shares. 

Conclusion

Conclusively, the investors and founders must be familiar with the factors that determine pre-money valuation according to the stage they are in and how to calculate their post-money valuation, equity stake or shares to be issued. This will ensure a clean cap table and an even more attractive investment negotiation round. 

Ecosystem updates


First Citizens’ bank buys Silicon Valley Bank
Recall the collapse of Silicon Valley Bank (SVB) on March 10, 2023, due to massive withdrawals of money and a decrease in investments. On March 27th, 2023 First Citizens Bank announced that it is set to buy all the deposits and loans of SVB. It would therefore appear that while the news spread on the failure of SVB, other banks were working behind the scene to acquire it with First Citizen Bank’s interest coming in as early as March 18, 2023. 
More info here 
https://cointelegraph.com/news/first-citizens-snaps-up-silicon-valley-bank-branches-open-monday


Inauguration of the National Council for Digital Innovation and Entrepreneurship
The Nigerian Government has inaugurated a 14-member National Council for Digital Innovation and Entrepreneurship to guide the implementation of the Nigeria Startup Act (NSA) 2022.
The members include Ministers of Communication and Digital Economy; Finance, Budget and National Planning; Industry, Trade and Investment; Science, Technology and Innovation; Governor of Central Bank of Nigeria (CBN),  one representative each from the Nigeria Computer Society, and the Computer Registration Council of Nigeria and the Director General of the Nigerian Information Technology Development Agency (NITDA), and four representatives of the startups’ consultative forum which included our Managing Partner, Davidon Oturu. 
President Muhammadu Buhari explained that the Act, which became law after its approval by the Federal Executive Council on 15th December 2021 and the Presidential assent on 19th October 2022, provides incentives and support for start-ups, such as tax breaks, access to funding, ease of doing business, intellectual property protection and participation in public procurement. .
More Info here 
https://www.thisdaylive.com/index.php/2023/04/05/buhari-inaugurates-14-man-national-council-to-implement-nigeria-startup-act-2022/


Shuttlers raises $4M
Shuttlers, a mobility solution across Nigeria has raised $4m in its funding round led byVerod-Kepple Africa Ventures (VKAV).
This is despite the global economic downturn in 2023 and an even more relaxed funding climate in Nigeria. 
We congratulate them and encourage solutions that solve real problems for Nigerians and Africans.
More info here 
https://techcrunch.com/2023/04/04/shuttlers-raises-4m-to-fuel-its-shared-mobility-solution-across-nigeria/
The Nubia way 
We at Nubia Capital are thrilled and delighted to bring you the biggest news in our industry. 
We have launched our $100m fund (Fund 1) dedicated to growth-stage startups in Africa.
We understand the power and potential in Africa and even more so, African-focused investors like Nubia Capital focused on unlocking the massive potential that remains untapped in the African startup ecosystem. 
Nubia Capital is dedicated to enriching Africa. We are still accepting pitch decks from growth-stage companies building in Africa. 
Send pitches to info@nubiacapital.org 

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