When receiving investment it is very important to understand how an investor is valuing your company, and what terms like ‘pre-‘ or ‘post-‘ money, and ‘diluted’ and ‘undiluted’ mean. These terms can help you understand exactly what an investor expects in terms of a future shareholding in your company, and how much they are willing to pay for it. Not understanding these terms could lead you to giving away more of your company than you intend, or giving away a share in your company at too low a valuation.
This article will guide you through how investors evaluate your businesses value and the terms they use, essential knowledge for every start-up.
Pre- and post- money valuations
In seed fundraising, investors will give a company cash in exchange for shares. If the investment is based on a ‘pre-money’ valuation of the company, this means the value placed on the company is worked out before the company receives investment. A ‘post-money’ valuation refers to the value of the company after the proposed investment. This means that a pre-money valuation of a company at £1m is the same as a post-money valuation of a company at £1.5m if the planned investment is £500k.
If an investor wants to invest £500k at a pre-money valuation of £1m, the company will end up being worth £1.5m and the investor will hold 33.3%.
If an investor wants to invest £500k at a post-money valuation of £1m, the company will end up being worth £1m and the investor will hold 50%.
Undiluted and diluted share capital
Undiluted share capital refers to the total issued share capital of a company. This includes all the shares which have been issued in a company, and which appear in the register of members and on Companies House.
Diluted share capital also includes various ‘rights’ to shares, which may not have actually been issued yet, such as options, warrants and convertible loans. This shows the percentage interest in a company someone might have if all the rights to shares materialised and resulted in newly issued shares in the company.
If an investor wants to buy a 10% share in a company on an undiluted basis, and the company has an option pool of 25%, the post-investment cap table might look like this:
Undiluted
| Shareholder | Pre-completion | Post-completion |
|---|---|---|
|
Founder |
100% |
90% |
|
Investor |
- |
10% |
|
Total |
100% |
100% |
Fully-diluted
| Shareholder | Pre-completion | Post-completion (to 1 decimal place) |
|---|---|---|
|
Founder |
90% |
81.8% |
|
Investor |
- |
9.1% |
|
Option pool |
10% |
9.1% |
|
Total |
100% |
100% |
This shows how important it is to clarify the basis on which the investment is being made and to understand the terminology of valuation. It can make a substantial difference to the amount actually being invested.