When you’re ready to expand, you need the funds to make it happen, and that sometimes means finding investors. Potential investors calculate the value of your company to determine how much equity they may get in exchange for the capital they invest. If you want to woo angel investors or venture capitalists, figuring out your company’s pre-money valuation can help. The pre-money valuation helps determine the value of your company before funding. As a small business owner, you should understand the meaning of this term, what it represents, and how it impacts your company to get an idea of how much funding you can get.
What Is Pre-Money Valuation?
Pre-money valuation is the value attributed to your company before it receives any public funding or outside investment. And this number is important because it helps determine the percentage of ownership investors claim after investment. But who determines pre-money valuation? In most cases, potential investors are the ones who adopt this valuation method. As the owner of the company, you also need to figure out how to calculate pre-money valuation.
Example of Pre-Money Valuation
Suppose an investor wants to inject $40,000 into your business, and you both agree that the company is worth $100,000. Your company is worth $140,000 after the investment. Based on those numbers, you own 60% of the company after the investment. The investor, on the other hand, claims a 40% stake in your company based on the amount of money they invest compared to the pre-money valuation of your company.
How to Calculate Pre-Money Valuation
There are many ways to calculate pre-money valuation, and one of these methods is the Dave Berkus method. Berkus bases his method on the idea that most time-intensive revenue forecasts aren’t accurate anyway, so instead, he does a more basic valuation based on estimates. This method is usually reserved for startups that can potentially reach at least $20 million in revenue by year five.
This method looks at five key areas that have the biggest impact. Those areas are:
- Quality management team
- Sound idea
- Working prototype
- Quality board of directors
- Product rollout or sales
You assign each of those areas a value between $0 and $500,000. The amount assigned is an estimate based on the strength of a given area, and it can be a bit subjective. Say you have a sound idea, quality management team, and quality board of directors in place. You might value those areas closer to the $500,000 mark. But you’re still finishing up the working prototype, and you haven’t actually rolled out the product yet. The working prototype might be assigned a number closer to $0, and the product rollout category is valued at $0 since you haven’t done anything with it yet.
With this method, a pre-money valuation for a new business can range between $0 and $2.5 million. If the company isn’t actually making any sales yet, the maximum is $2 million since the product rollout category is $0. If your startup excels in all five areas, you can assign $500,000 to each one for a total of $2.5 million. If you don’t have any of these areas in place, your valuation is $0. Your valuation can fall anywhere between those two numbers if you assign different numbers to the five categories. This valuation approach is simple to implement and makes for a great starting point.
How to Increase Pre-money Valuation
Creating a killer brand can help you add massive value to your business and ensure that you have an upper hand during negotiations. If you want to attract investors, create buzz around your brand. The name and reputation of your business matter during funding. So, invite influencers to display your art, use branded packaging, step up your game on social media, and use ads to increase your online presence.
Another place where you can impress potential investors is the executive summary section of your business plan. In the executive summary, write positively about your company by including the profit margins of your products, milestones for success, and the competitive advantage your company has over other businesses. You may also include your company’s efficient and reliable management.
Pre-money valuation is a great number to calculate and know going forward. If you, as a small business owner, decide to raise investor funds, you have a great idea of the true value of your business going into negotiations. 4.3 million customers use QuickBooks. Join them today to help your business thrive for free.