Valuation (pre- and post-money) and price
If you are seeking financing as a start-up founder, the valuation of your company that is agreed upon with the investor will determine the percentage of the company that you are selling (i.e. your dilution). Understanding the concepts of "pre-money valuation" and "post-money valuation" is crucial.
Pre-money valuation is the estimated value of a company before it receives any external investment. For example, if a start-up has a pre-money valuation of EUR 3m and an investor invests EUR 1m, the post-money valuation would be EUR 4m. The investor now owns 25 % of the company (1/4) and the founder or founders still own 75 %.
Post-money valuation is the value of a company after it receives external investment. It is simply the pre-money valuation plus the amount invested by the investor. In the above example, the post-money valuation of the start-up after the investment is EUR 4m. If the investor had invested EUR 1.5m, the post-money valuation would be EUR 4.5m. The investor would now own 33.33 % of the company (1.5/4.5), and the founders would own 66.67 %. In such a scenario, the founders sell more shares in the company and thus get more diluted.
Why pre- and post-money valuation matter and employee option pool
Knowing the pre- and post-money valuation is important because it affects the ownership percentage of the investor and founders after the investment. Always clearly communicate whether you are talking about pre- or post-money valuation and request the investor to be clear and transparent about this. If founders talk with an investor about a EUR 3m investment at a EUR 10m valuation, it is a significant difference whether EUR 10m is meant pre- or post-money. If pre-money is meant, the founders would sell only 23.08 % of the company (3/13). However, if post-money is meant, the founders would sell 30 % of the company (3/10). This is a huge difference.
Side note: Sometimes founders will come across a pre-money valuation, but an investor will at the same time request a new employee option pool (i.e. virtual equity that is reserved to incentivise employees). Let's look again at our previous example: if you agree on a EUR 3m investment at a EUR 10m post-money valuation, but the investor additionally requests a 10 % employee option pool, the founders would end up with an ownership of only 60 % (instead of 70 % without the employee option pool). Although the post-money valuation for the financing round will remain the same (in the above example EUR 10m) the requirement for a 10 % employee option pool will have a significant impact on the valuation and the ownership of the founders.
Price per share (nominal amount vs. contribution)
The price per share in a start-up financing round tells you (at least in relation to an Austrian limited liability company) how much EUR 1 of a fully diluted share capital of a company costs (see separate definition of fully diluted share capital). The price per share can be calculated by dividing the pre-money valuation by the fully diluted share capital of the company. For example, let's say a start-up has a pre-money valuation of EUR 4m and a fully diluted share capital of EUR 50,000. To calculate the price per share, we divide EUR 4m by EUR 50,000, which results in a price per share of EUR 80 (i.e. EUR 1 of the fully diluted share capital costs EUR 80). If an investor now wants to buy 20 % of the company, they must in total invest EUR 1m to get 20 % of a EUR 5m post-money valuation. At the same time the fully diluted share capital of the company needs to be increased by EUR 12,500 to EUR 62,500 (12,500 is again 20 % of 62,500).
In Austrian VC deals, the payment of the investment amount (EUR 1m in the above example) is typically split as follows:
In a first step the nominal amount is paid (in the above example: EUR 12,500) and in a second step the remaining amount (in the above example: EUR 987,500) is paid as a shareholder contribution. Here it is often a matter of negotiation whether the shareholder contribution is due immediately or only upon registration of the capital increase. Ultimately, it is a question of risk bearing, since in Austria shares are only created upon registration in the commercial register.
Legal vs. fully diluted share capital
In an Austrian limited liability company, the legal share capital and the fully diluted share capital represent various aspects of the company's ownership structure.
Legal share capital
The legal share capital refers to the total amount of capital that has been subscribed by the shareholders, paid into the company's account and registered with the commercial register. It is also the amount that is stated in the company's articles of association and it is fixed, meaning that it cannot be changed without amending the articles. The legal share capital reflects the legal ownership percentage of each shareholder in the company.
Fully diluted share capital
On the other hand, the fully diluted share capital refers to the total number of all outstanding (virtual) options, warrants, phantom shares or other rights convertible into shares. This considers any potential dilution of ownership that may occur because of these instruments. The fully diluted share capital is used to calculate the company's market capitalisation and to determine the economic ownership percentage of each shareholder in the company.
In summary, the legal share capital represents the fixed amount of capital that has been paid into the company by shareholders, while the fully diluted share capital considers the potential dilution of ownership that may occur because of outstanding instruments.