The EIR Corner

You feel outside investment will benefit your company, but you are unclear about how your ownership position may change. To shed some light on this topic, it is useful to review a list of common terms and calculations used by angels and venture capitalists:

a) Pre-money valuation - What your business is worth before investment

b) Investment amount - The capital (money) provided by the investor(s)

c) Post-money valuation - The pre-money valuation added to the investment (a+b)

d) Dilution - Investment divided by the post-money valuation (b/c)

Example: if you have a pre-money valuation of $3 million and received a $2 million investment, you would have a dilution of 40% (2 divided by 5). Another way to look at this is that you would now have 60% of what you had before. This math would be applied to each subsequent round of funding.

Your potential for reduced ownership, or dilution, is the relationship between the amount of capital you raise (investment) and the assumed value of your company (pre-money valuation).

Pre-money valuation is influenced by your entrepreneurial and business experience, market size, competitive advantage, the company’s stage of development and your market strategy. Although value will ultimately be determined by the investors in light of these factors, a well prepared and detailed business plan can clarify your message, reduce investor uncertainty and optimize your value.

Understanding how much capital you need is as important as what you will use it for. You should carefully estimate the funds required to reach your business objectives, support cash flows and maintain a suitable cushion for unknown risks. Capital efficiency should be an important part of your planning process.

Employing the right amount of investment and obtaining the best value of your company in the eyes of investors can result in a smaller dilution fraction. And that means a little more pie for you.