I’ve been thinking…Just what is the meaning of Pre-Money Value in a VCBF?
Pre-Money Value in a VCBF is a measure of value at the time of an investment round. This measure differentiates between value before and after a particular VC-led investment round of convertible preferred shares. Pre-Money Value also uses the VC industry convention that all available stock options (and/or warrants) are already issued and vested, the so-called fully diluted share count. Thus, an increase in the employee stock option pool will result in an increase in Pre-Money Value.
The dollar amount of Pre-Money Value is a function of the price per share determined in the negotiations between the lead VC and the VCBF in the instant investment round of convertible preferred shares. Such rounds are referred to as “series” and are commonly issued in alphabetical sequence (e.g., Series A, Series B, Series C). For example, the Pre-Money Value of a Series C round is calculated as follows: agreed upon price per convertible preferred share in the Series C round multiplied by the fully diluted number of shares (common and preferred) before the agreed upon number of convertible preferred shares are issued in the Series C round.
The measure of value after the investment round is referred to as the
Post-Money Value and is defined as Pre-Money Value plus the dollar amount raised in the specific investment round. For example, the
Post-Money Value of a Series C round is calculated as follows: agreed upon price per convertible preferred share in the Series C round multiplied by the fully diluted number of shares after the agreed upon number of convertible preferred shares are issued in the Series C round.
All this information (and more) is captured in the so-called capitalization table (or “cap table” for short), which is prepared for every investment round in a VCBF. While there are no hard and fast rules in the preparation of cap tables, such tables are used in part to convey to a reader relevant insights into the history of how the firm was financed from inception through latest investment round, including the use of common and convertible preferred shares, and the details of investor ownership in the VCBF after each investment round for each distinct investor.
Among the data contained in a cap table are the following:
(1) Founder Investment Details, including the amounts and dates of the founder’s investment of funds provided to finance the startup. At this stage, the founder typically owns 100% of the common shares and 100% of the firm.
(2) Pre-VC Investment Details, such as funds raised from friends and family and so-called angel investors (if any), including the number of shares, date(s) and price(s) and the cumulative percentage of investor ownership in the firm on a fully diluted basis at that particular round. At this stage, the founder’s 100% share common share ownership is diluted by the number common shares sold to other investors.
(3) VC Investment Round Details for each distinct sale of convertible preferred shares to VC investors, including name of the Series (e.g., Series A, Series B), the dates, prices and number the shares involved in each round and the percentage of investor ownership in the VCBF on a fully diluted basis for the investors in each round and on the cumulative basis. In my experience, it is typical that after the Series C round, the founder’s ownership percentage is less than the total share ownership positions of the set of VC investors in the Series A, B and C rounds.
In my experience, the share prices, amounts raised and the set of VC investors are invariably different between, for example, the Series A and Series C in the same VCBF. This is in part because the VCBF is different at the date of funding in each respective round. For example, at Series C, the VCBF is no longer a startup; it is more mature, possibly in a growth phase and requiring more capital. Also, the nature and extent of the negotiated preferred rights can be and often are materially different between Series A and Series C rounds. One reason is the make up of the set of VC investors is often different between the Series A and Series C rounds. This is part of a deliberate strategy: to recruit a new VC investor to lead the negotiations of the subject round, including leading a reasonable due diligence investigation. The initial term sheet proposed for this round is based in large part on the results of the due diligence investigation conducted and serves to set the stage for final negotiations of terms and conditions of that round.
Use of the VC industry convention in determining Pre- and Post-Money Value (i.e., using the fully diluted share count) essentially means that the convertible preferred share price of that investment round relates solely to the right to convert preferred shares to common shares. There is a singular advantage to adhering to the VC industry convention: it allows for the objective comparison of how Pre-Money Values change between, for example, Series A and Series B in the same VCBF. If the Pre-Money Value in a given convertible preferred round is lower than that of the previous round, then the new round is commonly referred to as a “down round.”
In my experience, VCs invariably negotiate the use of convertible preferred shares for each investment round (e.g., Series A, Series B). However, other valuable preferred share rights are not only negotiated by the VCs in each particular investment round, but those rights are also memorialized in the share purchase agreements documenting each separate round. Thus, in a particular VCBF, it is often the case that the preferred share rights of the set of VC investors in Series A, for example, are materially different from the preferred share rights of the set of VC investors in Series B. Other valuable preferred shares rights, such as Liquidation Preferences and Anti-Dilution Protection, will be discussed in the blog called, “A Deeper Dive into Pre-Money Value.”