So I’ve just been offered an investment in a company. The company has been valued at a pre-money figure. Pre-money valuations are a less than reputable tactic used in the VC industry to increase the value of a company and it works like this.
Your company is worth £1M, and you want to raise £500K, typically that would mean offering 50% of your equity in exchange. However using a pre-money valuation, your company theoretically becomes worth £1.5M once it receives the investment and so would offer 33% of it’s equity based on this.
Pre-money valuations have one valid use and only one valid use. If that money is being used to purchase an asset that will not decrease in value (such as a property) then the company does become worth £1.5M and that valuation will not decrease.
However in normal circumstances, the investment money is needed to invest in costs such as salaries, advertising or product development. These costs are outgoings and thus the money does not stay in the company, nor does it directly increase the bottom line. Therefore the value of the company will rapidly decrease again once investment is made.
For less experienced investors this may not be fully understood, so they may consider a pre-money valuation a valid method and a basis upon which to exchange equity.
I’m not a fan of companies that use this method!