The Nitty Gritty of Pre vs Post Money
Accelerating Asia invests up to US$250k into eligible startups joining the flagship 100-day program for Pre-Series A startups. We invest using a post-money SAFE note. Applications are now closed for investment but you can join the waitlist and find out more details here.
There seems to be some confusion these days about whether startups should price around at a “pre-money” valuation or a “post-money” valuation.
I’ve had founders say that potential investors are confused or complaining about one or the other.
Let’s explore what exactly these terms mean and how they affect a fundraising round.
For ease of explanation I’m going to ignore the variables of cap and discount and assume the SAFEs convert at the caps into equity. We’ll use SAFEs for the example as they are simpler than convertible notes and the document that Accelerating Asia uses for our investment rounds.
Pre-money means that the investment round is priced at a starting amount with the final valuation for the round being that starting amount plus the amount of investment raised.
Pre-money + Investment = Post-money
Let’s look at an example where an individual investor invests $100,000 in a pre-money round:
Pre-money valuation = $3,000,000
Amount raised (Total) = $1,000,000
Individual Investor = $100,000
Post-money valuation = $4,000,000
Investor Equity (Total) = 25% ($1,000,000/$4,000,000)
Investor Equity (Individual) = 2.5% ($100,000/$4,000,000)
Startups often prefer this as it gives them flexibility to raise more capital without diluting the existing shareholders as much and usually the founders themselves. So startups that are in a position of power with high demand for their equity may want to use this approach.
Investors sometimes don’t like this structure for the same reason given there can be uncertainty on how much of the company they will end up with.
To solve that, the round can also be given some boundaries, for instance, a resolution could be passed that the company will raise “up to XXX by XX date”. This allows the startup some flexibility to raise funds up to the ceiling provided by the resolution, but also creates some boundaries for investors to have some security around how much equity they will end up with.
Historically, pre-money was the most common way to structure convertible investment paperwork, but that has been changing and now post-money has become much more prominent for early-stage financing.
In fact, in 2018 the famous accelerator Y Combinator changed its investment SAFE from pre-money to post-money and that really tipped the scales in favour of post-money being the standard format for early-stage investing in Silicon Valley. It’s also how we at Accelerating Asia invest.
A post-money structure simply means that the ending valuation of the round is predetermined and any investment in the round will then be subtracted from that to create a pre-money number.
In a nutshell, pre-money is additive and post-money is subtractive.
In a pre-money round the pre-money valuation is set and the post-money valuation is determined later; in a post-money round the post-money valuation is predetermined and the pre-money valuation is determined later:
Post-money - Investment = Pre-money
Let’s look at an example where an individual investor invests $100,000 in a post-money round:
Post-money valuation = $4,000,000
Amount raised (Total) = $1,000,000
Pre-money valuation = $3,000,000
Individual Investor = $100,000
Investor Equity = 25% ($1,000,000/$4,000,000)
Investor Equity (Ind) = 2.5%
As you can see, the results are the same for investors in either the pre-money or post-money rounds in the examples we gave.
The difference would be that if the startup in the pre-money round was able to raise more capital, then the investors would end up with less equity per capita, whereas if the startup in the post-money example raised more capital, the dilution would come from the exisiting shareholders (usually the founders).
Let’s look at an example where the same examples are used but the startups raise $1,5000,000 instead of $1,000,000 in the pre-money round:
Pre-money valuation = $3,000,000
Amount raised (Total) = $1,500,000
Individual Investor = $100,000
Post-money valuation = $4,500,000
Investor Equity (Total) = 33.3% ($1,500,000/$4,500,000)
Individual Investor Equity = 2.2%
In this case the individual investor ends up with less equity as the round gets larger. There is also a risk that the startup takes in too much money and the cap table gets too complicated or becomes less attractive to future investors (see my blog on cap tables).
Let’s look at the same example but using a post-money round:
Post-money valuation = $4,000,000
Amount raised (Total) = $1,500,000
Pre-money valuation = $2,500,000
Individual Investor = $100,000
Investor Equity = 37.5% ($1,500,000/$4,000,000)
Investor Equity (Ind) = 2.5%
Here the investor receives the same amount of equity no matter how large the round is.
The excess equity would come from dilution of the exisiting shareholders (usually founders) instead of the new investors. You can see this clearly in the share of equity going to new investors (37.5% in the post-money example versus 33.3% in the pre-money example).
A post-money structure also provides some flexibility for the startup to take in more money than planned without upsetting the new investors, should that make sense for the business. I talk more about this fundraising strategy in my blog on drip financing.
At Accelerating Asia we invest through a post-money SAFE as we believe that it provides more clarity and alignment between investors and founders and is a simpler structure for early-stage investors to engage with. We believe most early-stage funding rounds would benefit from this structure as well, but there is certainly space for both pre-money and post-money structures to work in different circumstances.