Key points
- Fundraising starts from the premise that the startup has a value that can rise sharply when an investment is made.
- A distinction is drawn between pre-money valuation (before investment) and post-money valuation (after investment).
- A startup’s value is relative: it depends on the project and above all on the people behind it, even without any turnover.
- The funding requirement, plus a safety margin, determines the percentage of capital granted to the investor.
- The price paid by the investor is split between the nominal value of the share and the share premium.
- Example: 20% of the capital for €200,000 gives a post-money valuation of one million euros and a pre-money valuation of €800,000.
How does a company or a start-up run its fundraising round?
The specific startup ecosystem is not exempt from the rules that apply to any other company, even though, in the startup model as we know it today, fundraising is seen as the main route.
It all starts from the premise that the startup has a value that can rise considerably when an investment is made. In this respect, we speak of pre-money value or valuation (before investment) and post-money value or valuation (after investment).
What makes a startup specific is that its valuation is not necessarily calculated using the usual accounting methods.
In fact, it is not unusual, especially for a first funding round, for the startup to generate little or no turnover. That does not mean it has no value. Its value is relative: it depends on the project but above all on the people behind it.
Entrepreneurs regularly ask themselves several important questions as a fundraising round approaches:
- How much should we raise?
- Which investor should we choose: business angels, seed funds or crowdfunding?
- How should the fundraising round be carried out, and what lawyers’ fees should we expect for the transaction?
In concrete terms, there are tangible elements to take into account to guide the parties in valuing the startup.
The founders will therefore provide financial documents (business model, business plan, executive summary, presentation, etc.) setting out, based on the data available to them, a user or customer acquisition cost, which will make it possible to define a funding requirement.
Once this requirement is known (plus a safety margin), the founders will need to assess the percentage of capital they are prepared to grant the investor in return for the investment.
In practice, the investor and the founder will therefore negotiate the value of the startup. Depending on the valuation agreed and the amount invested, the percentage of capital taken by the investor will be known.
Simulation:
If the startup agrees to give up 20% of its share capital for €200,000 paid by an investor, the company will be worth €1 million after the investment (post-money value).
It follows that the pre-money value was €800,000.
The founders’ shares thus increase in value, which creates an unrealised capital gain, realised only if the shares are sold. It is this capital gain that founders and investors are seeking.
Share price in a fundraising round
The investor will not pay the same price for the shares as the entrepreneur did when setting up the company. The price paid by the investor is split into two parts:
- The price at the nominal value of the share: this is the value of a share as set by the articles of association;
- The share premium: the difference between the nominal value of the share and the price paid by the investor; new shares may be issued at their nominal amount plus a share premium (Article L. 225-128 of the French Commercial Code (Code de commerce) (in French)).
For example, suppose the startup has a share capital of €2,000 divided into 2,000 shares. Each share is therefore worth €1. The company will need to issue 500 new shares if 20% of the capital is offered for €200,000. As stated above, there will be 500 shares with a nominal value of €1 (€500) and the difference as share premium (€200,000 – €500 = €199,500), spread over 500 shares (199,500 / 500 = €399 per share).
After the investment, the startup’s new share capital will be €2,500, with a share premium (recorded in
equity under the “share premium” item) of €199,500
For assistance: fundraising lawyer.
