Investing in a startup through SPVs comes with a high level of risk, but it also offers the potential for significant rewards. As a startup founder or angel investor, it’s essential to understand how to calculate a startup’s post-money valuation accurately. Valuation is crucial for determining a startup’s value, and the amount of equity investors will receive.
In this article, we’ll delve into how to calculate post-money valuation, focusing on the startup’s value, financing rounds, and equity dilution.
What is Post-Money Valuation?
Post-money valuation refers to the value of a startup after the infusion of new capital from investors. It’s the sum of the pre-money valuation and the amount of new fundraising investment.
Suppose a company’s pre-money valuation is $1 million, and an investor invests an additional $500,000. In that case, the startup’s post-money valuation would be $1.5 million. This post-money valuation is used to determine the investor’s ownership percentage in the company.
The startup’s value and financing rounds
The first step in calculating post-money valuation is determining the startup’s value. Various methods exist for valuing a startup, including the discounted cash flow (DCF) method, the market approach, and the alternative approach.
However, these methods may only sometimes be feasible, especially for early-stage companies with a considerable revenue stream or market share.
In such instances, valuation sometimes relies on the startup funding raised during the financing round. The valuation considers the startup’s perceived value, growth potential, revenue, and market share, all negotiated into the price per share. To determine the pre-money valuation, multiply the negotiated price per share by the number of shares outstanding.
Equity Dilution
Equity dilution refers to a reduction in the percentage ownership of existing shareholders due to the issuance of new shares. Equity dilution can result from new funding rounds, stock options, warrants, and convertible notes.
Raising funds through equity financing involves selling the startup’s shares to investors in exchange for capital. As a result, the ownership percentage of existing shareholders reduces proportionately with each financing round. For example, suppose an early-stage startup raises $1 million in exchange for 20% of equity ownership. In that case, the startup has a pre-money valuation of $4 million. If a later-stage startup funding round results in an additional $5 million investment, the post-money valuation would be $9 million.
The new valuation for investment brings the total startup funding to $6 million ($1 million + $5 million). The post-money valuation is, therefore, $9 million ($4 million pre-money valuation + $5 million new investment). The Investor who invested $5 million now owns 55.5% of the company, diluting the equity ownership of early-stage investors to 44.5%.
Calculating Post-Money Valuation using Equity Dilution
Equity dilution has a significant impact on post-money valuation. As a result, it’s crucial to calculate the number of outstanding shares and adjust for new ones issued after each financing round.
The equation for calculating post-money valuation using equity dilution is:
Post-money valuation formula = (Pre-money valuation x Existing shares outstanding) / (Existing shares outstanding + New shares issued)
Suppose a startup has a pre-money valuation of $3 million and 1 million outstanding shares before the next funding round. Angel investors invest $2 million for 400,000 new shares. In this example,
Post-money valuation = (Pre-money valuation x Existing shares outstanding) / (Existing shares outstanding + New shares issued)
Post-money valuation = ($3 million x 1 million) / (1 million + 400,000)
Post-money valuation = $2.31 million
The post-money valuation of the startup is $2.31 million after the new valuation for investment.
Angel investors can also use the above formula to determine the startup’s percentage of ownership.
The equation for calculating percentage ownership is:
Percentage ownership = Investor’s shares / Total shares outstanding
If an angel investor invested $400,000 for 400,000 shares of the startup, the percentage ownership of the Investor would be:
Percentage ownership = 400,000 / (1 million + 400,000)
Percentage ownership = 28.57%
Conclusion
The post-money valuation formula is critical in determining a startup’s value and investors’ percentage of equity ownership. Calculating this valuation using equity dilution is essential to determining the startup’s value after each financing round and adjusting for equity dilution.
Angel investors and startup founders should understand the factors influencing valuation, such as the startup’s value, financing rounds, and equity dilution. By following these steps and considering the associated risks, they can make informed decisions and increase their chances of success in the startup ecosystem. Want to know more? Contact us at +1 (209) 231-4575.
