I was approached by a listener the other day who was contemplating investing in a friend’s business.
He was the first money in and was trying to figure out how much equity his investment bought.
There’s an equation for determining equity ownership.
There are three terms in the equation. Pre-money valuation – how much the company is worth before investing. The investment amount, and post money valuation which is how much the company is worth after the investment.
Pre-money plus investment = post-money
For example, if you had a business with a pre-money valuation of $4M and the investment going is $1M, then the post money valuation is $5M.
The equity ownership by the investor is investment divided by post-money.
In this example $1M divided by $5M is 20%.
Let’s say in another case, the pre-money valuation is $19M, the investment is $1M, so the post-money valuation would be $20M.
The investor would get $1M divided by $20M or 5% in this scenario.
In every valuation discussion, the startup is negotiating the pre-money valuation up and the investor is negotiating it down.
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Hall T Martin is the director of Investor Connect, which is a 501(c)(3) nonprofit dedicated to the education of investors for early-stage funding. All opinions expressed by Hall and podcast guests are solely their own opinions and do not reflect the opinion of Investor Connect. This podcast is for informational purposes only and should not be relied upon for the basis of investment decisions.