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