Simply put,
valuation is about how much the shares of your company are valued at.
In a private
limited company, ownership is decided on the basis of equity shares. The % of
shares you own defines the % of your ownership of the company.
Let us
understand with an example. I am of course over simplifying for the purpose of
ease of explaining and understanding.
Ramesh and Suresh start a company. They both own 50% each of the
company.
A few months later, Ramesh and Suresh approach an angel investor who
decides to invest Rs.50,00,000 [INR 50 lacs / USD 100,000] in their company for
which he takes 20% of the company. In this scenario, the post-money valuation
of the company would be Rs.250,00,000 or Rs.2.5 cr [USD 500,000]. This is
because Rs.50 lacs got the investor 20% equity, so the value of 100% is Rs.250
lacs or Rs.2.5 cr.
Stated differently, the company got a pre-money valuation of
Rs200,00,000 or Rs.2cr [USD 300,000]. In this scenario, Ramesh and Suresh now
own 40% each in the company, with 20% being owned by the investor.
Later, the company decides to raise Rs.10 cr [USD 2 mn] from a VC
who takes 20% of the company. In this scenario, the post money valuation of the
company is Rs.50cr [USD 10 mn]. Stated differently, the company raised Rs 10 cr
at a pre-money valuation of Rs.40 cr [USD 8 mn]. With this round, Ramesh,
Suresh and the angel investor each get diluted by 20% and hence the capital
structure or cap table stands as follows:
Ramesh 32%
Suresh 32%
Angel Investor 16%
VC 20%
In both the rounds, the money invested by the angel investor and the
VC has gone into the company and not to Ramesh and Suresh.
Going further, the company does well and the VC decides to increase
their holding to 26% and offers to buy 6% of the shares held by the angel
investor for Rs. 10 cr. [USD 2 mn]. Now, the valuation of the company is Rs.166
cr or USD 33mn. Even at this stage, when the valuation of the company is Rs 166
cr, Ramesh and Suresh have not made any money. However, the angel investor has
had a successful exit with a 20x return on his original investment, and still
retains 10% in the company.
At this stage, the capital table will look like this:
Ramesh 32%
Suresh 32%
Angel Investor 10%
VC 26%
At a later stage, Ramesh and Suresh decide to dilute their holding
and decide to sell 5% equity each to another VC for which each get Rs.20 cr
[USD 4mn]. At this stage, the 2nd VC decides to also buy the 10%
held by the angel investor for Rs.20 cr. Hence, now the valuation of the
company therefore is Rs.200cr or USD 40mn, and the cap table will look as
follows:
Ramesh 27%
Suresh 27%%
Angel Investor ----%
VC 26%
VC 2 20%
This of
course is a rather simplified version of reality, but done only to illustrate the
concept.
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