Overview
If you’ve looked at raising money, whether through an equity round or a convertible (like a SAFE), then you’ve probably come across one or both of the terms pre-money and post-money. They are used in a few different ways, primarily split across the concept of valuation and capitalisation. Here are some examples of used terms in a pre-money context:
pre-money valuation;
pre-money capitalisation;
fully diluted capitalisation on a pre-money basis;
company capitalisation on a pre-money basis; and
liquidity capitalisation on a pre-money basis.
You may have seen any of these terms in your convertible, in a term sheet or in discussions with your investors. It’s quite a complex topic that you should seek professional, financial advice on, but we will try and give you a high-level understanding of the basic concepts here. Let’s go through each main concept below.
Valuation (most relevant in the context of an equity round)
A pre-money valuation simply means the valuation of your startup without taking into account the money you are about to raise (i.e. what it is worth today before any funding).
A post-money valuation is the valuation of your startup taking into account all the money that you are about to raise (i.e. what it will be worth once you close your equity round).
For example, if your startup is valued at $20m today and you are raising $5m in an equity round, your pre-money valuation is $20m and your post-money valuation is $25m.
Capitalisation (most relevant in the context of a convertible)
This may be referred to as your fully diluted capitalisation, company capitalisation or liquidity capitalisation, but the concept is essentially the same (the different terms are used in different contexts depending on the reason or mechanic related to why you need to calculate your startup’s capitalisation – see examples below). For simplicity, we will simply refer to this as fully diluted capitalisation.
A fully diluted capitalisation on a pre-money basis takes into account any existing shares any options over shares (typically including those related to share incentive plans), but excludes any shares to be issued pursuant to other convertibles (e.g. if you are entering into a number of SAFEs, it excludes all the shares that will be issued to investors under all of those SAFEs).
A fully diluted capitalisation on a post-money basis also takes into account any existing shares any options over shares (also typically including those related to share incentive plans and may include a wider definition which also includes shares that are reserved but not granted to any team member), and includes any shares to be issued pursuant to other convertibles (e.g. if you are entering into a number of SAFEs, it includes all the shares that will be issued to investors under all of those SAFEs).
Clara Tip: You will typically not see the words pre-money or post-money in the definition of capitalisation in a convertible. The way you can figure out whether it is on a pre-money or post-money basis is to read what the inclusions and exclusions are, as explained above. You should know that the current market practice is to use post-money not pre-money, but there might be cases where pre-money can be considered.
Why does it matter?
In the context of an equity round, it doesn’t much matter, as you always start calculating your valuation on a pre-money basis and add in the amount you will raise (which will be a known quantity before you sign your equity round documents).
However, in the context of a convertible with a valuation cap, the difference can potentially be material. In a nutshell, if your startup ends up raising more money than anticipated by way of convertibles before your next equity round, using pre-money shifts the risk of extra dilution resulting from that additional convertible funding (i.e. the extra shares that will have to be issued to those extra investors) on to the investors because they will know get less shares than they may have anticipated when they invested in your convertible round early on (e.g. they may have thought you were raising $1m seed round by way of convertibles, but you ended up raising $3m before your next equity round). If you use post-money, that risk of dilution gets shifted onto the existing shareholders (typically just the founders).
Why is this case? Because when you calculate your post-money valuation cap in a convertible, you start with an assumption of what the pre-money valuation cap would be and you add to that how much you think you will raise in your convertible round before you do your next equity round. If you raise more than what you accounted for by way of convertible, the post-money valuation cap stays the same, so your effective pre-money valuation cap decreases. For example:
Assumed pre-money valuation cap of $10m
Accounted for a convertible raise of $2m
Agreed a post-money valuation cap of $12m
If you end up raising $3m instead by way of convertibles before your equity round, your post-money valuation cap will remain $12m
Your effective pre-money valuation cap is now $9m
This means the investor dilution stays the same and the founder dilution has increased.
Now let’s take a look at what that would look like on a pre-money basis:
Assumed pre-money valuation cap of $10m
Founders and investors assumed at the time that it would be a convertible raise of $2m, but no post-money valuation cap has been agreed in the convertible
Actual amount raised by way of convertibles before the equity round was $3m
Your agreed pre-money valuation caps stays at $10m, but your effective post-money valuation cap has now gone up to $13m.
This means the founder dilution stays the same and the investor dilution has increased.
TL;DR
This is one you should really read in full, but here’s a summary anyway!
Pre-money and post-money concepts will come into play whenever you are raising money, whether by an equity funding round or convertibles.
The distinction is particularly important when entering into convertibles.
Pre-money shifts more dilution risk to investors if you end up raising more money than anticipated by way of convertibles.
Post-money shifts more dilution risk to founders if you end up raising more money than anticipated by way of convertibles.
You might not necessarily see the words pre-money or post-money, so to determine which is being used take a close look at the inclusions and exclusions in the definition of fully diluted capitalisation, company capitalisation and/or liquidity capitalisation.
It’s always best for you to get some financial advice on this, it can have a very material impact on dilution.