Did you find a difference between the company’s fair market value within the 409A valuations and the post-money equity valuation? It is more common than you might think. Often, companies will face a major gap between the two valuations and there is a good reason behind it. This mini-article will show you how each valuation concludes its findings and why the difference often happens.
Because its main purpose is fundraising, it does not require any particular complex calculation method and founders can come up with the numbers by themselves. More than that, this valuation can be used as a negotiation tool and reflects the founders' belief in the company but not necessarily the reality.
To calculate the post-money valuation, use this formula: Investment amount ÷ what the investor receives (in %). For example, an investment amount of 1M with an offer of 10% shares to the investor will result in a post-money valuation of 100K (1M ÷ 10).
This very precise process is mostly based on data and doesn’t take into consideration the market trends and expected growth. Mainly performed by a trusted professional, coming by a 409A valuation requires the use of a complex calculation method. In the case of a deal concluded in the past six months prior to the valuation, the calculation will be done in a method called Backsolve (on most occasions).
You probably figured up until now why the difference exists. But if not, here is the simplified explanation: both contain different calculating methods and variables. The post-money valuation does not include any share preferences, discounts, or other benefits shareholders hold. A 409A valuation, on the other hand, contains cold data alone, without growth expectations, market trends, and so on.
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