Why is the 409A valuation different from my post-money valuation?
It’s important to consider the shortcomings of the definition of post-money valuation. The most common definition of post-money valuation is:
Post-money-valuation = Pre-money valuation + Investment
With a bit of rearranging, you get:
Post-money valuation = Investment / % Ownership
The nuance that sheds light on the issue of the above equation is that the % Ownership is on an as-converted basis. However, two important facts should be considered:
- When investors purchase shares, they purchase and own Preferred Shares in your company, which have better economic terms than Common Shares (namely, they are senior in the liquidation preference), and
- There is a high likelihood that your startup will produce returns that are less than the liquidation preference, which means that your ownership would be paid less than that of the Preferred Investors [linkto FanDuel Deal].
Given these facts, the value of the Common Stock is arguably lower than the value of the Preferred Stock.
The more accurate description of your company Equity Value would be:
Post-Money valuation = Value of Preferred Shareholders + Value of Common Stockholders + Value of Debtholders.
Although investors, lawyers, and founders negotiate the terms of financing in a pre-money and post-money terms (for various reasons), the 409A valuation is a much more accurate representation of facts and circumstances.