The valuation of a startup is a measure of how much the startup is worth to an investor. This is at a particular point in the life cycle of the startup, at a particular point in chronological time.
Pre-money valuation for a startup is a venture capital concept for the valuation of a startup, just before an investment is made. Some use the term more restrictively to mean the valuation just before an initial public offering (IPO).
Both angel investors (usually at an early stage) and venture capitalists (usually at a later stage), estimate the pre-money valuation for a startup. They use this as a part of their calculation of what amount of equity to request in exchange for their investment in a startup. The final pre-money valuation is the result of negotiation between the startup and the investor(s).
The post-money valuation is the sum of the pre-money valuation for a startup, plus the actual investment made by the investor in the startup.
Most startups obtain one or two seed rounds of investment, followed by several rounds of venture capital investment (referred to as A Round, B Round, C Round, etc.), before their ultimate financial exit. Pre-money and post-money valuations are calculated for each round. Investment offers from investors are expressed in terms of both pre-money and post-money valuations.
Pre-money valuation= post-money valuation- new investment
Significance of pre-money valuation for a startup
The pre-money valuation is important since it establishes whether a startup has an outstanding, good, average or, perhaps, no investment opportunity.
If the pre-money valuation of a pending round is larger than the post-money valuation of the just prior round, the round is deemed to be an upround. In other words the startup improved in value. However if the pre-money valuation is lower than the post-money valuation of the just prior round, then the investment is called a downround. In other words the value of the startup deteriorated.