How do pre-money and post-money valuations work in venture capital?
CFA Level II covers the venture capital method of valuation. I understand that a VC invests money and gets ownership, but the pre-money and post-money terminology confuses me. Can someone walk through a deal from term sheet to ownership percentage with actual numbers?
Pre-money and post-money valuations are the core of VC deal structuring. They determine how much of the company the investor receives for their investment.
Definitions:
- Pre-money valuation: What the company is worth before the new investment
- Post-money valuation: What the company is worth after the new investment
- Relationship: Post-money = Pre-money + Investment
Investor ownership:
> Investor % = Investment / Post-money valuation
Full Worked Example — Helix Robotics (fictional Series A):
Situation: Helix Robotics is a 2-year-old startup with a working prototype. Redwood Ventures wants to invest.
| Term | Value |
|---|---|
| Pre-money valuation | $12 million |
| Investment amount | $3 million |
| Existing shares outstanding | 4 million |
Step 1: Post-money valuation
Post-money = $12M + $3M = $15 million
Step 2: Investor ownership
Redwood's stake = $3M / $15M = 20%
Step 3: Price per share
Pre-money price per share = $12M / 4M shares = $3.00/share
Step 4: New shares issued to Redwood
New shares = $3M / $3.00 = 1,000,000 shares
Step 5: Updated cap table
| Shareholder | Shares | Ownership |
|---|---|---|
| Founders | 3,200,000 | 64.0% |
| Early employees (ESOP) | 800,000 | 16.0% |
| Redwood Ventures (Series A) | 1,000,000 | 20.0% |
| Total | 5,000,000 | 100% |
The VC Method — Working Backward:
VCs typically start with the expected exit value and work backward to determine what pre-money valuation they can accept.
| Input | Value |
|---|---|
| Expected exit value (Year 5) | $100 million |
| Required return (IRR) | 40% per year |
| Investment | $3 million |
Step 1: Required future value of investment:
FV = $3M x (1.40)^5 = $3M x 5.378 = $16.13M
Step 2: Required ownership at exit:
Ownership = $16.13M / $100M = 16.13%
Step 3: Post-money valuation implied:
Post-money = $3M / 0.1613 = $18.6M
Step 4: Pre-money valuation:
Pre-money = $18.6M - $3M = $15.6M
So Redwood should accept a pre-money valuation no higher than $15.6M to achieve their 40% target IRR.
Key Nuances:
- Dilution from future rounds. If Helix raises a Series B, both founders and Series A investors get diluted. VCs account for this by requiring higher initial ownership.
- Anti-dilution protections. Preferred shares often have anti-dilution clauses (weighted-average or full ratchet) protecting VCs in down rounds.
- Liquidation preference. VCs get their money back first in a liquidation event — this means post-money valuation overstates the effective price the founders received.
Exam tip: CFA Level II questions typically give you exit value, required return, and investment amount, then ask for the implied pre-money valuation or investor ownership percentage. Nail the VC method formula and the dilution adjustment.
Learn more about private equity valuation in our CFA Level II course.
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