TODAY ON REASONED REFLECTIONS:

• Pre-money valuations 🤑;

• Startup News 🚀;

• Venture Capital News 💰;

• Other Tech News 💻.

Reflection No. 2: Understanding Pre-Money Valuations in Equity Financings

I - Issue: What is pre-money valuation, how is it determined, and how does it impact equity financings?

R - Rule: The pre-money valuation establishes the company’s value just before any new cash investment. This valuation is typically a point of negotiation between the company and investors. Ultimately, the pre-money valuation is used to calculate the price per share that investors will pay during the financing round.

A - Analysis: Control and economics are the two most important things to remember when negotiating a term sheet. Pre-money valuation is the economics piece as it determines the company's current value (before any new investment is made) and how much dilution will occur to its existing stockholders. 

The process of determining pre-money valuation is highly subjective and often lacks a strict formula, especially for early-stage startups with limited financial data. Investors rely on metrics such as comparable businesses, target markets, the quality of the founding team, competitors, and the level of investor interest.

Once a company starts making money, investors may use a revenue multiple to calculate the pre-money valuation. This involves multiplying the company’s gross revenue over a 12-month period (either forward or backward) by a revenue multiple, for example, 10x.

If the company and the investor cannot agree on a pre-money valuation, they may use convertible instruments such as convertible notes or SAFEs (Simple Agreements for Future Equity). Using convertible instruments allows the company to obtain funding quickly and punts the pre-money valuation negotiation down the road. Some convertible instruments may have a valuation cap. However, it's important to note that the valuation cap does not determine the company's value—it simply represents the highest valuation at which the convertible instrument will convert into equity.

Finally, the pre-money valuation determines the price per share (PPS) investors will pay in the equity financing. The PPS is calculated by dividing the pre-money valuation by the company’s fully diluted capitalization. For example, if a company has a pre-money valuation of $12 million and its fully diluted capitalization is 10 million shares, the price per share would be $1.20 ($12 million / 10 million shares).

C - Conclusion: Understanding pre-money valuations is crucial for equity financings since they impact deal dynamics, share price, dilution, and investment and business decisions.

Startup  🚀, Venture Capital 💰, and Other Tech News 💻

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• All you need to know about the European Union’s AI Act

• New feature released for developers by OpenAI

• Elon is back at it with an OpenAI lawsuit

• Moxxie Ventures raises its third fund

Quote of the Reflection

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