Valuation – how pre-money valuation shapes your funding round

read time: 4 mins

10.01.25

Sam Brown

Pre-money valuation is one of the most critical components of a venture capital term sheet. It is the metric that determines how much of your company you are giving away in exchange for investment and sets the stage for how investors and founders view the value of the business. For founders, it can feel like the ultimate scorecard, while for investors, it’s a calculated starting point for structuring their investment.

This insight in our ‘Anatomy of a term sheet’ series unpacks the concept of pre-money valuation, explores its impact on your term sheet and beyond, and offers insight into how founders and investors view this pivotal number differently.

What is pre-money valuation?

Pre-money valuation is the value of your company immediately before an investment round. It represents the agreed-upon worth of the business on a ‘fully diluted’ basis, accounting for all outstanding shares, convertible securities, and employee stock options.

It is called “pre-money” because it does not include the new capital that the investors are injecting into the business. Once the investment is factored in, the company’s valuation is referred to as the post-money valuation, which equals the pre-money valuation plus the amount of investment.

For example:

A company agrees on a £10 million pre-money valuation.
An investor agrees to invest £2 million
The post-money valuation becomes £12 million (£10 million + £2 million).

How pre-money valuation affects ownership

The pre-money valuation directly determines the percentage ownership the investor will receive.

Using the example above:

If the post-money valuation is £12 million and the investor contributes £2 million, they own 16.67% of the company (£2 million / £12 million).
The remaining 83.33% is shared among the existing shareholders.

For founders, a higher pre-money valuation means retaining more ownership, but it is not without trade-offs.

The role of the option pool in pre-money valuation

One area where pre-money valuation can become a flashpoint is the treatment of the employee stock option pool (ESOP). Investors often require the company to create or expand the ESOP to incentivise employees, but whether the pool is factored into the pre- or post-money valuation significantly affects founder dilution.

The option pool shuffle

Investors typically insist that the ESOP is established or topped up pre-investment, meaning the dilution from the option pool comes entirely from the existing shareholders, including founders. For example:

If a company with a £10 million pre-money valuation creates a 10% ESOP before investment, the effective pre-money valuation decreases.
Instead of £10 million, the effective pre-money valuation is £9 million, as the option pool is factored into the calculation.

Founders should negotiate for the ESOP to be created post-investment, so the dilution is shared between existing shareholders and the new investors. This approach ensures more equitable dilution.

You can read more about share options their impact on the cap table, and the considerations for both founders and investors here.

Negotiating pre-money valuation: what’s at stake?

Pre-money valuation is not just a number - it’s a reflection of a company’s potential and risk profile. Investors typically calculate it based on the following:

Market comparables: valuations of similar companies in the same industry and stage.
Financial metrics: revenue, growth rate, and profitability (if applicable).
Qualitative factors: the founding team, market opportunity, and intellectual property.

Founders, on the other hand, may take a more optimistic view, focusing on the company’s future growth potential rather than its current financials.

Analysis: founders’ perspective vs investors’ perspective

	Founders' perspective	Investors’ perspective
Motivations	Founders want the highest possible pre-money valuation to minimise dilution and retain control. They view the valuation as a measure of their hard work and future potential.	Investors aim for a valuation that justifies the risk of their investment while ensuring sufficient upside on exit. They prioritise fair valuation to protect their returns.
Preferred Position	A high valuation reflecting their confidence in the business. ESOP creation post-investment to reduce personal dilution.	A valuation grounded in conservative metrics. ESOP creation pre-investment to align employee incentives without diluting their ownership.
Risks	Overvaluing the company can lead to difficulty in raising future rounds, especially if growth expectations are not met, potentially triggering a down-round.	Overpaying for equity may reduce returns, while underpaying could jeopardise the relationship with founders.
Where they align	Both parties ultimately share an interest in a valuation that enables growth. A valuation that is too low can demotivate founders and employees, while one that is too high can jeopardise future funding. Striking a balance ensures that both parties are incentivised to work toward a successful exit.

In summary

Pre-money valuation is the cornerstone of a VC term sheet. It sets the tone for the entire negotiation, influencing dilution, control, and future fundraising potential. Founders must approach this term with a clear understanding of its implications, while investors must balance their risk and reward calculus.

Read the next article in our ‘Anatomy of a term sheet’ series, exploring the differences between ordinary and preference shares , and breaking down how share classes impact both financial and control rights.

If you're navigating the complexities of venture capital term sheets or preparing your business for investment, our experienced team is here to help. Get in touch to discuss how we can support you in securing the right deal for your business.

Our anatomy of a term sheet series

Our 'Anatomy of a term sheet' series breaks down each critical section of a venture capital term sheet, offering technical insights and practical real-world examples to help founders with their fundraising journey.

Our aim is to demystify term sheets and empower founders and their advisors to navigate negotiations with clarity and confidence.