Pre-Money vs Post-Money Valuation
Private equity valuation sounds simple enough, so what’s all this talk of pre-money vs post-money? How can a business have a different valuation at the same point in time?
It generally comes down to the purpose and use of your investment. There are two broad options:
- Existing Capital – e.g. buy-out an existing stockholder, retire some debt, etc.
- New Capital – e.g. invest for growth, invest to make an acquisition, etc.
If you swap your new capital for existing capital (buying out another shareholder or paying down debt), then there’s generally no change to the valuation. However, if you are investing cash as new equity (for growth and/or acquisitions), then you’re increasing the equity value of the business and hence, increasing the EV and overall valuation.
Pre-money vs Post-money
A quick example: we value a company with EBIT of $20m using a multiple of 5x. It has debt of $50m, no material amount of cash and therefore, equity value of $50m and EV of $100m.
In scenario 1, I’m paying down $50m debt. This means I’m swapping my $50m of equity for the $50m of debt. This transfer of capital means we now have $100m of equity , but $0 of net debt, so still an EV of $100m. As you can see, the EV and overall value didn’t change.
In scenario 2, I’m investing $50m to make a new acquisition. My investment enters the business as new equity to fund the acquisition. Total equity is now $100m, net debt is still $50m and hence EV is $150m.
In scenario 1, the pre- and post-money valuations were the same, both $100m. In scenario 2, pre-money was $100m, whereas post-money was $150m. This is all due to the new equity injection.
Like most things, there’s a caveat to this. In scenario 1, we swapped different types of capital, which mean they have different risk and return profiles. Most financial analysts would argue the value of the business changed due to the change in capital structure. However, we tend not to go into this detail in private equity for a few reasons (e.g. we’re not operating in efficient markets, our preference equity more closely resembles debt, we do the deals we can irrespective of theoretical nuances, etc.)
So, at least for simplicity, pre-money vs post-money valuation only differ if new equity is invested in a business.
