Pre-money and post-money valuation
The cornerstone of any VC deal is the pre-money valuation—the company’s worth before new investment. This figure sets the price per share, calculated by dividing the pre-money valuation by the fully diluted share count, which includes issued shares, employee stock options, and potential shares from convertible instruments like warrants or debt. For example, a £10 million pre-money valuation with 1 million fully diluted shares results in a £10 share price. Post-money valuation, by contrast, adds the new investment to the pre-money figure, reflecting the company’s value after the round. These metrics are critical, as they determine how much equity investors receive and how much ownership founders retain.
Market trends and valuation multiples
Market conditions heavily influence valuations. Over the past 18-24 months, economic uncertainty has driven down multiples, with Software-as-a-Service (SaaS) companies now typically valued at 6-8x annual recurring revenue, compared to 10-12x during peak markets. Early-stage startups may face even lower multiples, as investors prioritise proven traction over potential. Understanding these trends helps founders set realistic expectations and negotiate effectively.
Tranche investments and milestones
VC investors often mitigate risk by investing in tranches, tying funds to milestones outlined in the Subscription Agreement. This approach is common in sectors like life sciences, where funding may depend on clinical trial progress. However, milestones can create tension if market conditions shift, rendering original goals obsolete. Disputes over milestone achievement can complicate funding, so clear, flexible terms are essential. Founders should negotiate for higher valuations on future tranches to reflect growth, ensuring alignment with investors.
Ratchets and shareholding adjustments
Ratchets are mechanisms that adjust shareholdings based on performance or exit outcomes, often used to bridge valuation disagreements or incentivise founders. For instance, an exit ratchet might grant founders additional equity if the company sells above a target value. While effective, ratchets require careful structuring to avoid tax complications or conflicts among shareholders. When designed well, they align interests and drive performance.
Conclusion
Valuing a company in VC transactions demands a nuanced approach, blending pre-money and post-money calculations with market insights and strategic tools like tranches and ratchets. By understanding these elements, founders and investors can negotiate fair valuations that foster trust and fuel growth. In today’s cautious market, a transparent, well-informed valuation process is more critical than ever to building lasting partnerships.
If you have queries on any of the topics discovered in this article, please do get in touch.
Authored by Alex Falco and Kartik Monga
