VALUATION OF PRIVATE EQUITY TRANSACTIONS

There are certain terminologies that are intrinsic to valuation exercises performed by VCs / PEs,these includes:
(i)    Pre-money and post-money valuation: Simply put, pre-money valuation is the value of the
enterprise before the investment; and post-money is the valuation after the investment by the VC. For example – assume a startup has a share capital of ` 10,000 represented by 1000 equity shares of Rs. 10 each. X, a VC, has shown interest to do an initial funding of ` 4000 worth represented by 400 equity
shares.
In this case the pre-money valuation is INR 10,000 (before investment). The post-money valuation will be the fully diluted impact on the equity which will be computed using the following formula:
New Investment Amount* (Total shares post investment ÷ Shares issued in new investment)

In the example, the post-money valuation will as –

	Number of shares	Face Value	Valuation
Pre-money	1000	10	10,000
Post-money
Existing	1000	10	10,000
New Investment	400	10	4,000
Post-money shares outstanding	1400	10	14,000
Post-money Valuation			14,000

Note: The above illustration is a simplistic representation of how pre and post money valuation works in mathematical terms. In real life, the VC would perform a valuation based on due diligence and the value would either be at a premium or discount. 

(i) Ownership dilution: Each additional investment from the VC will end up diluting the ownership control of the management of the enterprise. In the example above, the effective ownership control of management has gone down from 100% to 71.43%. If there is a further round of investment, the management control evan will well go below 50%. Anti-dilution clauses are mandated in the term sheet to help overcome this problem. The number of shares to be issued will be adjusted to maintain the ratio of holding. 

(ii) Liquidation Preference: It is an important term associated with Private Equity financing. This term provides preference to receive fund by VC over and above preferred and common stock holders in the event of liquidation or deemed liquidation. 

(iii) Series A and B: Series A will be the initial round of funding, whereas Series B are the subsequent rounds of funding, which are usually after the enterprise achieves certain pre-determined milestones. 

(iv) ROI: The rate of return that the enterprise would offer to the investor (VC) on the investment. 

(v) Terminal Value: The value of the enterprise that would be at the end of the time frame of the investment cycle of the VC, used at the time of acquisition / sale to a third party. An Exit Multiple would be used, usually calculated as on Enterprise Value (EV/EBIDTA), that the VC has been expecting to obtain at the exit through selloff. 

(vi) Tranches: The investor (PE or VC etc.) will bring the funds only based on certain agreed ‘milestones’. The funding is, thus, made in parts or ‘tranches’. 

(vii) Deemed Liquidation: This term implies in addition to liquidation, it includes change of control, acquisition, amalgamation etc., sale of a company or sale of most of its assets. As mentioned above deemed liquidation normally are considered trigger events for liquidity preferences.