Valuations and Values

Pre-money valuation, post-money valuation. Equity value, enterprise value. Fully-diluted, non-diluted. Founders, investors, and purchasers may refer to different things when talking about valuation. And quite often I see cases where the value in question is misunderstood.

In this article, I aim to demystify these terms and clarify the differences between equity and enterprise value, pre- and post-money value and fully- vs. non-diluted value.

Pre-money valuation vs. post-money valuation

The question that typically arises in the first funding round of the company: What is the difference between pre- and post-money valuations?

Pre-money valuation equals the (equity) value of the company before the funding round, while the post-money valuation equals the value after the round when the money is assets of the company.

So if the pre-money valuation is 2.25 million and the round size 250 thousand, the post-money valuation is 2.5 million (pre-money valuation of 2.25 million + investment 0.25 million = 2.5 million).

Instead of valuation, it is also possible to express the stake offered to the investors in the round. So it the previous example, instead of saying 2.25 million pre-money valuation one could say that 10% of the shares are offered in exchange for 250 thousand investment (10% x 2.5 million = 250 thousand).

Fully diluted valuations vs. non-diluted valuation

When the company is having an option pool or when the investors require an option pool to be created in connection to the funding round, differences between fully-diluted and non-diluted valuations rise to the agenda.

The company may issue options, convertible and other rights that give the holder of the right a right to acquire shares in the company. Fully-diluted valuation refers to the valuation when all these rights have been subscribed as shares, while non-diluted valuation refers to the current situation, i.e. the valuation based on the current number of outstanding shares.

As an example, if a startup holds an option pool of 10.000 shares and the company has 90.000 shares outstanding and gets offered and pre-money valuation of 2.5 million on fully-diluted basis, the subscription price per share would be 25.00 (2.5 million / (90.000+10.000)); whereas if the same valuation would be offered on non-diluted basis the price per share would be 27.78 (2.5 million / 90.000). So with a round of 250 thousand, valuation on a non-diluted basis would cause dilution of 9% (250 thousand / 2.75 million) and on a fully diluted basis would cause dilution of 10% (250 thousand / 2.5 million).

Enterprise value vs. equity value

This difference typically arises in exit where the purchaser talks about enterprise value while the founders and investors are more accustomed to using equity value.

In a nutshell, enterprise value is the value of the business of the company, whereas equity value is the value of the shares in the company. While this seems quite straight-forward, confusion may arise because the founders typically talk about equity value (i.e. the valuation of the company) while the purchasers are more accustomed to talking about enterprise value (i.e. the valuation of the business of the company).

The equity value of the company equals the enterprise value of the company deducted by net debt (i.e. the debt part used in financing the company) and adjusted by the difference between working capital and normalized working capital (i.e. the working capital the company would require for its normal operations).

As an example, if the purchaser offers 4.5 million (enterprise value) for a company that has 1.0 million in debt, the actual purchase price for the shares offered (equity value) is 3.5 million (4.5 million - 1.0 million = 3.5 million).

Point of view

Due to their line of business, investors and purchasers are more accustomed to different valuation terms and how they are used than what the founders typically are. Therefore, it is important that the founders acquire a basic understanding of the relationship between different terms and their meanings in order to be able to assess any investment or purchase proposals received. If there is contradictory in valuations due to the use of different terms there is a likely risk that the lower one will be used as a basis of the discussion going forward.

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