The Post-Money Lie
Let’s say you have a box full of scrap metal and copper, 100 pieces in total. I propose to buy 20 pieces of your box for $100 (20%). This would imply that your box is worth $500 after I buy the 20% ($100 / 20%). Here’s the lie: When I proposed to buy 20% of your box, you agreed to sell me all of the copper pieces (all 20 of them), while you held on to the scrap metal (the other 80 pieces). Only with blood, sweat, and tears (and plenty of luck) the scrap metal and the copper would both turn into gold (alchemy, unicorn love, whatever). Otherwise, the copper remains copper, and the scrap metal remains scrap metal. Effectively, Copper = Scrap Metal + (Blood + Sweat + Tears)*Luck. So saying that I have purchased 20% of your box is a lie, since the pieces that I have bought and the pieces that you are holding are not the same (i.e. apples and oranges, or copper and scrap metal, so using % is an incorrect mathematical expression). If we want to use %, we have to PROPERLY convert the two pieces together (apples-to-apples).
For those who haven’t gone through a fundraising process, the copper (or the 20%) represents Preferred Stock (has some value, mostly keeps value, and has the potential of being something great), while the scrap metal represents Common Stock (the other 80%, nearly value-less, remains valueless, until it converts into something great: big exit).
The good folks at Correlation Ventures have assembled some great information on this. Below shows the return to U.S. Venture Capital. In nearly 2/3rd of instances, the Common Stock will get nothing:
In 50% of those instances where the Common Stock gets nothing, the Preferred Stock gets some of its money back because of its Seniority and Liquidity Preference (through forced acqui-hires, sale, IP spin-off, bankruptcy, board approved dividend distribution, etc). Because of this fact, the Preferred Stock is inherently worth more, just like the copper is worth more than the scrap metal.
Without having to get into the mathematics of it, the VALUE of the Common Stock is generally about 25% of the VALUE of the most recent round of Preferred Stock (given the above Seniority and Liquidity Preference). That means, if the Preferred Stock was worth $1 / share, the Common Stock would be worth about $0.25 / share (the mechanics of this for another post). Inversely, the Preferred Stock is worth 4x the Common Stock.
Back to our original example: Since the copper is worth 4x in VALUE, then dollar for dollar, my $100 is worth $400 in scrap metal. So let’s take this copper-to-scrape metal comparison and turn it into a scrape metal-to-scrape metal. Since I could buy 4 scrap metal pieces for every 1 copper piece, we can get a box where you have 80 scrap metal pieces (from the original holding) and I’ll have 80 scrap metal pieces (my original 20 copper pieces, converted at the 4x value conversion). So with that said, my $100 has effectively purchased 50% of the VALUE in your box. So the VALUE of your box is $200 ($100 / 50%). You can see how the $200 is not equal to the $500 that you had original thought.
It’s important to understand this differentiating factor: In only a few cases Preferred Stock and Common Stock both convert to Common Stock, and only in those cases the VALUE of the Common Stock = Preferred Stock, and ONLY in those instances can one compare them as apples-and-apples to say one is a % of the other. When the original investment happens, the Preferred Stock is not equal to the Common Stock, and explaining them as a % of each other is misleading: It makes the value of the Company seem much higher than it actually is, so founders would be willing to give away more than they should.
So when you hear a Post-Money valuation of $500M, don’t compare it to a publicly traded company with a Market Value of $500M. They are not the same. A Post-Money valuation of $500M is about $200M in actual Market Value.
Hopefully the above explains some of the craziness that is Post-Money valuation.
Note: As companies mature, the VALUE of the Common Stock starts converging to the VALUE of the Preferred Stock (i.e. IPO). In these instances, the Post-Money valuation converges to Market Value.










