The valuation of a company used to calculate the price of the common or preferred equity securities to be sold in a venture capital financing. As its name suggests, the pre-money valuation does not take into consideration the capital the company will receive in the pending financing.

The purchase price for the security is calculated by dividing the pre-money valuation by the fully diluted capitalization of the company. For example, if a corporation has a pre-money valuation of $4.5 million and a fully diluted capitalization of six million shares, then it would sell shares of preferred stock in the financing for $0.75 per share. For a more complete discussion of establishing the purchase price for securities in a private equity or venture capital transaction, see Practice Note, Growth Equity Investments: Box, Establishing Price Per Share: Illustration.

Pre-money valuation is often tied to a financial valuation of the company, but in practice pre-money valuation is ultimately arrived at by negotiation between the company and the investors. In venture capital financings, investors often propose a pre-money valuation subject to certain requirements, such as:

The final negotiated value reached by the parties and eventually used in the purchase price calculation normally factors in any existing discrepancy or failure to satisfy any of these requirements. Other factors can also affect the negotiations over pre-money valuation.

These factors tend to increase the pre-money valuation of the company:

These factors tend to decrease the pre-money valuation of the company:

Corporations, limited liability companies, and partnerships all use pre-money valuations to calculate the price of common or preferred securities.