Pre-Money Valuation

What is the pre-money valuation?

Pre-money valuation (valuation before the funding round) describes the value on which the company and investors agree for all existing shares of a company before the new capital is paid in. Together with the investment amount, it determines what price the new investors pay per share and what ownership stake, that is, what percentage of the company, they hold after the round. The German term is Pre-Money-Bewertung.

A simple example: a company is valued at EUR 8 million before the round, and an investor pays in EUR 2 million. Afterwards it is worth EUR 10 million, and the investor owns 2 of EUR 10 million, that is, 20%. What is meant is a price for the shares, not the equity on the balance sheet and not the value of the entire business operations including debt (Enterprise Value).

The pre-money valuation is agreed in the term sheet, the document setting out the key terms of the round, and implemented in the participation agreement through a capital increase. Unlike the value in a valuation report, it is the result of negotiation and competition among investors. The counterpart is the post-money valuation, the value immediately after the round.

Calculating the pre-money valuation: formula and price per share

Formula: pre-money valuation = post-money valuation minus investment amount = price per share × number of shares before the round

The remaining calculation steps follow from this. The stake here means the share of a participant in all shares after the round:

• Post-money valuation = pre-money valuation + investment amount
• Stake of the new investors = investment amount / post-money valuation
• Price per share = pre-money valuation / number of shares before the round on the agreed basis
• Number of new shares = investment amount / price per share

The actual negotiating variable is the price per share. A pre-money valuation is unambiguous only if it is clear by what number of shares it is divided, that is, which future shares for employees or from convertible loans are included in the basis.

The fully diluted basis

Dilution means that a shareholder's stake falls because new shares are added. On a fully diluted basis (Fully Diluted), the calculation is therefore made as if all future shares already promised had already been issued. In funding rounds, the pre-money valuation is usually agreed on this basis. As a rule, this includes:

• all existing shares according to the shareholder list (Gesellschafterliste), the list of shareholders filed with the commercial register
• allocated virtual shares from the employee programme, regardless of whether they are already vested, that is, definitively earned
• the not yet allocated part of the employee pool, that is, of the shares reserved for future employees, and any agreed increase
• shares from the conversion of outstanding convertible loans in this round, that is, loans that are repaid in shares instead of money
• other commitments to shares, for example to advisers or former employees

What enters the basis before the round increases the number by which the pre-money valuation is divided. This lowers the price per share and the value attributable to each existing share. The new investor's stake is unaffected by this, because it follows solely from the investment amount and the post-money valuation. The delimitation of the basis therefore decides how the agreed value is divided between the existing shareholders on the one hand and employees, lenders and other entitled parties on the other.

Employee pool before or after the round

The size of the employee pool is usually fixed as a percentage after the round, for example 10% on a fully diluted basis. This does not yet decide who bears the dilution:

• Pool in the pre-money valuation: The pool is created before the round and included in the number of shares by which the pre-money valuation is divided. It dilutes only the existing shareholders. The value of their shares lies below the stated pre-money valuation by the value of the pool. This remaining value is called the effective pre-money valuation.
• Pool after the round: The pool is created after the investor has entered and dilutes all participants proportionately, including the investor. Investors rarely accept this, because their stake is then below the agreed one.

In German growth companies, the pool consists predominantly of virtual shares. Employees do not receive shares but a contractual claim to a payment on a sale. This is measured by the value of real shares (virtual stock option plan, VSOP, a form of ESOP). Virtual shares do not appear in the shareholder list. They are nevertheless included in the fully diluted basis like shares, because the payments to employees reduce the sale proceeds of all shareholders.

Implementation in a GmbH: nominal amount and additional payment

In a GmbH (German limited liability company), the investor takes new shares from a capital increase. The resolution on this is notarially recorded and becomes effective on entry in the commercial register. Each share has a nominal amount, with which it stands in the share capital (Stammkapital), the liable capital of the GmbH entered in the commercial register. This must be in whole euros and is therefore at least EUR 1 (Section 5(2) and Section 55(4) of the German Limited Liability Companies Act, GmbH-Gesetz, GmbHG); in funding rounds EUR 1 per share is usual. The price per share is far above this. The difference is a premium (Agio) and is shown in the balance sheet as capital reserves, a component of equity alongside the share capital.

There are two routes for the premium. If it is fixed in the capital increase resolution itself, it is part of the contribution obligation under company law and passes into the capital reserves under Section 272(2) no. 1 of the German Commercial Code (Handelsgesetzbuch, HGB). In growth rounds the second route is common. The investor takes the shares at the nominal amount and undertakes in the participation agreement to make an additional, purely contractual payment (schuldrechtliche Zuzahlung under Section 272(2) no. 4 HGB). This structure permits partial payments by milestone (tranches) without burdening the capital increase itself.

Worked example: pre-money valuation with and without an employee pool

A GmbH has 42,000 shares with a nominal amount of EUR 1 each. An investor offers EUR 3 million at a pre-money valuation of EUR 12 million.

Base case without an employee pool

• Post-money valuation: 12 + 3 = EUR 15 million
• Investor's stake: 3 / 15 = 20%; the existing shareholders keep 80%
• Price per share: EUR 12 million / 42,000 = around EUR 285.71
• New shares: EUR 3 million / EUR 285.71 = 10,500 (exactly: 42,000 × 3 / 12); check: 10,500 / 52,500 = 20%

The same case with an employee pool in the pre-money valuation

After the round, a virtual pool of 10% on a fully diluted basis is also to exist, which is included in the pre-money valuation.

• Investor's stake unchanged: 3 / 15 = 20%
• Share of the existing shareholders after the round: 100% minus 20% minus 10% = 70%; total shares: 42,000 / 0.7 = 60,000
• Pool: 10% of 60,000 = 6,000 virtual shares; investor: 20% of 60,000 = 12,000 new shares
• Price per share: EUR 12 million / (42,000 + 6,000) = EUR 250; check: 12,000 × EUR 250 = EUR 3 million
• Effective pre-money valuation of the existing shareholders: 42,000 × EUR 250 = EUR 10.5 million
• Implementation: capital increase by EUR 12,000 nominal amount and additional payment into the capital reserves of 12,000 × EUR 249 = EUR 2,988,000

In both cases the investor pays EUR 3 million for 20%. The difference is borne solely by the existing shareholders. With a pool, their fully diluted share falls from 80% to 70%, and the price per share falls from around EUR 285.71 to EUR 250. The stated valuation of EUR 12 million therefore contains a pool worth 6,000 × EUR 250 = EUR 1.5 million. Two offers can therefore be compared only via the effective pre-money valuation and with the same pool size.

Distinctions: pre-money valuation, post-money valuation and equity value

• Post-money valuation: the pre-money valuation plus the investment amount. It is the reference point for the investors' stake and the benchmark for the next round.
• Equity Value: in a company acquisition, the value of the equity. It is derived from the enterprise value by deducting financial debt and adding cash. The pre-money valuation, by contrast, is negotiated directly for the shares.
• Down Round: a later round at a lower price per share than the previous one. Whether a round falls under this is shown by the price per share, not by the level of the new pre-money valuation.

Common mistakes

• Pre and post not specified. If EUR 3 million is committed at a "valuation of EUR 12 million", the investor receives 20% if the figure applies before the round and 25% if it applies after the round.
• Number of shares not fixed. Without an express number of shares before the round, it remains open whether the pool, commitments and conversion shares are included in the basis.
• Pool sized in a blanket way. A pool with no link to the hiring plan lowers the effective pre-money valuation without a concrete need.
• Convertible loans overlooked. If loans convert at a discount in the round and are included in the basis, the value per existing share falls further.
• Valuation viewed in isolation. A high pre-money valuation can be less favourable for the founders than a lower one if it comes with a multiple or participating liquidation preference. This gives the investor priority in the distribution of sale proceeds.

Frequently asked questions

How is the pre-money valuation calculated?

By deducting the investment amount from the post-money valuation. For a rough calculation, the investment amount and the investor's stake suffice: EUR 5 million for 25% gives a post-money valuation of EUR 20 million and a pre-money valuation of EUR 15 million.

How is the pre-money valuation determined?

Mostly through negotiation on the basis of reference values. Valuations of comparable rounds, revenue multiples (the value as a multiple of annual revenue), growth, market size and the plan are used. For profitable companies, classical valuation methods are added, such as the capitalised earnings method (Ertragswertverfahren) or the discounted cash flow (DCF) method, which discounts future cash surpluses to today's value. The decisive factor is often competition among several investors for the round.

Does the investor's money go to the founders?

No, not in a capital increase. The money flows into the company and is available to it for growth. The founders receive nothing paid out, but their stake falls because new shares are created. Only if the investor additionally buys existing shares (secondary) does this part of the money go to the selling shareholders.

Does the pre-money valuation have to be supported by a valuation report?

No. It is a negotiated result and is checked neither by the register court nor by the notary. For tax purposes, however, the price of a funding round can serve as an indication of the value of shares, for example if shares are later issued to employees.

Can a lower pre-money valuation be advantageous?

Yes. A moderate valuation with simple terms lowers the risk that the next round has to take place at a lower price per share. Such a down round often triggers the contractual anti-dilution protection of earlier investors, which gives them additional shares at the expense of the founders.

The Roemer Capital view

Roemer Capital fixes the basis of calculation with the shareholders before the first conversation with investors about the pre-money valuation takes place: which shares, virtual shares, pool increases and conversion shares are included. Roemer Capital then converts every incoming offer to the effective pre-money valuation of the existing shareholders. Only this figure makes offers with different pools and different treatment of convertible loans comparable.

Roemer Capital derives the pool size from the headcount plan of the financial model, which maps at least three years with a base, a conservative and an optimistic case. In this way it can be justified to the lead investor, who leads the round, which pool is actually needed until the next round.