What Is Post-Money Valuation, and Why Should You Know About It
From 2011 to 2022, the number of unicorns in the Indian startup ecosystem has increased to 100. These unicorns have collectively raised over $ 90 billion and have a combined valuation of about $ 333 billion. By 2025, the number of unicorns in India is expected to rise to over 250.
Despite these optimistic predictions, startups must be aware of the ground realities and be cautiously optimistic in their fundraising journeys.
According to a report featuring 120 startup founders across various sectors and growth stages, only 53 % of startup founders had a positive fundraising experience in 2022. Various factors influence the success of a startup’s fundraising efforts and the journey thereafter.
The concept of post-money valuation impacts the ownership and profitability of a business. Understanding the concept and leveraging it is essential to make informed decisions during the fundraising process.
What is post-money valuation?
Post-money valuation is the estimated worth of a business after it receives funding from a venture capitalist or angel investor. On the other hand, the projected value of a company before the fund-raise is referred to as a pre-money valuation.
The exercise of determining the post-money valuation helps both founders and investors realize the potential value of the startup based on the specific terms and conditions of the fundraise.
This is an important metric used to make critical decisions around aspects like equity ownership and the amount of funding to be received to help the company meet its goals.
Significance of post-money valuation
When startup founders seek funding, they must be prepared to part with some amount of equity. However, giving away equity means relinquishing control of the company.
Venture capitalists seek more equity in exchange for funding to get more control and a higher rate of returns on their investment.
Both parties have to negotiate extensively to arrive at the final agreement. During this process, the post-money valuation is a significant indicator, helping businesses to determine how much equity they are willing to part with for raising the desired amount of funding.
How to calculate Post-money valuation
The post-money valuation of a company can be calculated as follows:
Post-money valuation = Pre-money valuation + Capital Investment
Say a company’s pre-money valuation is projected to be Rs.10 crores, and a venture capitalist agrees to fund them to the tune of Rs.2 crores in exchange for 10% equity.
Then the Post-money valuation = Rs.10 crores + Rs.2 crores = Rs.12 crores
Since the investor receives 10% equity, they now own Rs.1.2 crores, while the founder would own 10.8 crores.
However, if the investor instead asks for a 20% stake, then they would own Rs.2.4 crores, while the founders would own Rs.9.8 crores.
A higher post-money valuation can prove to be a double-edged sword.
On the one hand, a high post-money valuation indicates that investors believe the business is worth a lot of money. It creates buzz in the startup ecosystem and makes headlines.
On the other hand, it comes with the pressure of delivering a higher return on investment for investors.
Secondly, as the post-money valuation of a startup grows higher, it usually results in more equity needing to be given away.
This can be an issue if the company aims to raise more funds in future rounds; they increasingly have lesser equity to offer.
Hence, post-money valuations must be done accurately and rationally for businesses to grow sustainably and profitably after the fundraising.
Post-money valuation guidelines for founders
A report released earlier this year indicated that funding for Indian startups in CY22 saw a drop of 33% as compared to CY21, though it was higher than funding raised in CY20 and CY19.
In such a volatile climate, founders are advised to follow be cautious and follow some basic guidelines when going about raising funds:
1. Avoid early dilution
Founders must avoid early dilution in the process; a higher post-money valuation often comes at the expense of giving away too much equity.
2. Know the exact capital you need
Startups must have a very clear idea of their exact capital needs. The funding to be received must be strategically mapped to specific needs, and startups must avoid taking on excess capital.
3. Smooth fundraising process
The fundraising process must be well-planned and executed, with the right financial projections on metrics like post-money valuation for the company to reap the full benefits of the capital injection.
4. Importance of a viable business model
Startups must have a strategic plan to meet their sales targets and honor their commitments to investors.
5. Combining equity and credit
While equity is one asset founders can part with, startups can sometimes resort to a mix of equity and credit to retain equity ownership of the company.
A company’s post-money valuation plays an important role in its future. It determines how much equity stays with the founders and the rate of returns they are expected to deliver to investors.
Hence, this term carries significant weightage and needs to be calculated optimally.
The best approach for startups is to seek expert advice to navigate fundraising decisions with a long-term perspective on sustainability and profitability.
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