One of the most critical and important phases of a start-up is the possibility of obtaining external financing, which is only possible after a pre-money valuation.
The pre-money valuation is an effective tool to establish the value of a start-up at an early stage. This valuation determines the amount of shares to be sold to each individual who chooses to participate in the financing operation. Founders will obviously aim for a good pre-money valuation that makes their start-up as attractive as possible and enhances its strategic assets and potential.
It is in the interest of all parties involved that the pre-money valuation is correct, so that they are satisfied at the end of the funding round.
How to calculate the pre-money value
Unfortunately, there is no single, universal method recognised by all stakeholders. Several methods can be used to obtain a pre-money valuation, which involve a certain amount of subjectivity. The most famous and widely used are the Venture Capital Method and the Multiples Method.
The Venture Capital Method is based on the expected Return On Investment (ROI) and Terminal Value. The first is the return on investment index. The latter measures the expected sale price of the startup after a period of 5-8 years. Since ROI is equal to the ratio between Terminal Value and Post-money Valuation, the final formula can be summarised as follows: Post-money Valuation = Terminal Value / Expected ROI.
For the Multiples method, indicators are used that estimate the value of the company based on that of similar companies. This is because similar companies provide a very reliable reference point for the valuation of the target company as they share the main business and financial characteristics. Research on the values of other companies is carried out through all the documents and materials that can be found on the selected companies, from financial statements to periodic reports, investor prospectuses and rating agency reports.
Pre-money: a crucial value for the future of a start-up company
It is clear that, although this value is not always easy to calculate, it is a crucial element in the financing phase of a start-up.
The aspiration of both founders and investors is for the new company to be as successful as it should be. At the same time, however, it is important to obtain a value that is neither undervalued nor inflated.
If the pre-money valuation is too high, then the funder may consider it unprofitable to invest a large sum for a small fraction of shares. If, on the other hand, the pre-money valuation is too low, the founders will find it difficult to control the new company because of too large shareholders.
In general, a correct pre-money valuation allows for the sale of between five and twenty per cent of the shares. In these terms, both founders and financiers get a fair return for their efforts.
It is therefore clear that an effective collaboration between the company's founders and investors is absolutely essential for a correct pre-money valuation and, in general, for the future success of the company.