How To Measure Your Startup’s Valuation
By Alida Miranda-Wolff
This post originally appeared on Medium and is part of the Hyde Park Angels Entrepreneurial Education Series, which brings together successful, influential entrepreneurs and investors to teach entrepreneurs everything they need to know about early-stage investment through events, articles, videos and more.
As an early-stage entrepreneur, one of the first things you learn is that the valuation of your company is important. Every Shark Tank episode focuses on the drama and negotiations around valuation. In fact, the beginning of every Shark Tank pitch starts off in the following way:
Entrepreneur: “I am seeking a $## investment in exchange for a ##% equity stake in my company.”
One of our newest portfolio companies, Packback, actually experienced this first hand on Shark Tank when they negotiated and struck a deal with Mark Cuban.
But if you’re just starting, or even been in the game awhile, it’s important to know there’s more to valuation than standing in front of an investor and asking for $## in exchange for ##% equity stake.
In a nutshell, valuation is the financial worth assigned to a business. This sounds simple enough, but you have to remember there are layers to measuring valuation. Let’s dig in deeper and look at a scenario where a company is taking on its first investment capital since they started the business.
Pre-Money and Post-Money Valuation
However, to begin, let’s take a moment to define the two different ways valuation is defined.
- Pre-Money Valuation: The valuation of the company right now, prior to investment.
- Post-Money Valuation: The pre-money valuation plus the total investment amount.
The Pre-Money Valuation is determined based on a number of factors involving the stage of the business and is negotiated between the entrepreneur and the investor. Additional details on Pre-Money Valuation will be covered in a future blog post.
The Post-Money Valuation is determined based on a mathematical equation outlined below.
Pre-Money Valuation + Total Investment Amount = Post-Money Valuation
Example: $4M (Pre-Money Valuation) + $1M (Total Investment Amount) = $5M (Post-Money Valuation)
Let’s go a layer deeper to understand how this valuation is being measured based on price-per-share, or the price for each share of stock in the company.
Where does the first set of shares come from? Every company has a certain number of shares, which is how valuation is calculated. When a company is first formed, shares are created and issued to the founders. The number of shares originally issued at the formation of the company is arbitrary, but provides the foundation for all future shares.
Since the number is arbitrary, this means the shares originally issued are up to the founder’s discretion, whether that’s 100 shares, 3M shares, 8M shares, etc. There are some best practices around how many shares to issue in order to make the math easier, but generally speaking the number of shares originally issued is arbitrary. As the company takes on additional investment, more shares are added based on a calculation that we will review further in the next section.
Now that we have a better understanding of shares, lets continue with our example of a company receiving their first investment capital. Let’s say the founders decided on 8M shares, which we will now refer to as Pre-Money Shares.