PMV vs FMV vs Enterprise Value. Why Would Valuations Differ?

Understanding the difference between Pre-Money-Valuation and Fair Market Value and Enterprise Value can help you navigate fundraising and negotiation discussions. Finance degree not required.

In the three minutes that it will take you to read this piece, the value of Apple, Inc. (NASDAQ: AAPL) may have gone up or down by more than $100 million.

More astonishing is that from the time that you woke up today until you go to sleep, its value could go up or down by more than $10 billion.

Daily AAPL Value Volatility

People still can’t agree on what is the “value” of Apple, Inc., even though it is the most valuable public company in the world, with 97% of its shares actively trading, more than 30 dedicated analysts following its stock every minute, nearly 30 years of quarterly and annual public records, clock-like product releases, and worldwide followings.

On the most basic level, some people believe Apple’s stock is always going to go up and thus it is a good time to buy, and some people believe it’s overpriced, going to go down, and thus a good time to sell. This is why you may hear that “valuation is more of an art than a science” and that no one can predict the future political and economic environment (except for the creators of the Simpsons™) and its effect on stock prices.

To make matters more complicated, “value” is use-case specific.

“This is going to be great!!!”

At its core, valuation is a narrative told with numbers. As a seller, you’re trying to paint a rosy picture. As a buyer, things may seem unrealistic and you see risks. More importantly, when a transaction is happening, the buyer and seller must consider the specific circumstances at hand. The saying “beauty is in the eyes of the beholder”, as when Microsoft buys LinkedIn, is because there are unique opportunities for Microsoft to be close to a network of professionals. Caterpillar, Inc., on the hand, is unlikely to pay the same price to acquire LinkedIn. In assisting either LinkedIn or Microsoft during the transaction, buyer-specific synergies would need to be considered.

“Steady as she goes”

Whether it’s to comply with Internal Revenue Code Section 409A or to present appropriate financial statements, companies are required to report the “true value” of their assets, liabilities, or equity positions. In these instances, there are no buyer-specific synergies that can be analyzed to assess the value to the buyer. So we have to consider a “Going Concern” or view the value of those assets, liabilities, or equities in the eyes of a hypothetical buyer or seller, known as a “market participant”. This is a very different view on value than one that considers buyer-specific synergies.

Bad Math

“Pre-money valuation” and “post-money valuation” are synonymous with venture capital and startup finance. They are also mathematically incorrect and misleading figures. 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

This equation actually comes from the idea that “I’ll give you $ investment for % ownership, so after I give you that money, your company must be worth $ Investment / % Ownership, or:

Post-Money Valuation = Investment / % Ownership

One nuance which may help shed some light on the above equation is that the % Ownership is on an as-converted basis, which means there are two important facts to consider:

  1. When investors purchase shares, they commonly purchase and own Preferred Shares in a company, which have better economic terms than Common Shares (namely, they are senior and have liquidation preference), and
  2. There is a high likelihood that a startup will produce returns that are less than the liquidation preference, which means that Common Shareholders would be paid less at the end of the day than that of the Preferred Investors [see heart wrenching FanDuel exit].

Given these facts, the value of the Common Stock is arguably lower than the value of the Preferred Stock, and so the Post-Money equation fundamentally inflates the value of the company (and is misleading) as it assumes that the Common Stock and Preferred Stock are economically equivalent.

So what is the “value” of company XYZ?

It depends. But keep three things in mind:

  • Value is in the eyes of the beholder.
  • No one can predict the future.
  • Valuation is a narrative told with numbers. The story (the reasons for why the business does what it does) and the numbers (the quantification and interdependencies of the past, future, and various current functions) are equally important, and equally difficult to to nail down with precision.

If you are trying to comply with tax reporting requirements, dealing with financial statement preparation, or contemplating a transaction and/or strategic initiative that would benefit from an independent financial analysis, we’d love to help. Shoot us a note at [email protected] and we’ll be in touch.

PMV vs FMV vs Enterprise Value. Why Would Valuations Differ?