Valuation and terms: a plain-English guide for first-time founders

You will be asked for a valuation and you will be offered terms. Neither needs a finance degree, but both need understanding before you agree to them, because the decisions you make in a £400k round shape what you own after a £4m one. This is the plain-English version a good solicitor would give you across a table.

Pre-money, post-money, and the percentage

Pre-money is what the business is valued at before the new money goes in. Post-money is pre-money plus the amount raised. The investor's percentage is the amount raised divided by the post-money.

Worked: you raise £400,000 at a £1.6m pre-money. Post-money is £2.0m. The investors own £400k ÷ £2.0m = 20%. You and your existing shareholders own 80%. If instead you had said "£1.6m valuation" and the investor heard post-money, they would expect 25%. Always say which you mean; the difference is the argument.

How early-stage valuations are actually set

Not by a formula. Discounted cash flow on a two-year-old company is fiction and everybody knows it. Early-stage valuations are set by four things pulling against each other:

What the traction supports. Revenue multiples are the common shorthand: a software business doing £200k ARR and growing 10% a month might raise at 8–15× ARR; a café doing £1.1m at 14% margin is valued on profit, perhaps 4–7× EBITDA plus the value of signed leases.
What comparable raises went for. Investors know what similar businesses at similar stages raised at last year. So should you.
What the investor needs to own. A seed investor putting in £100k typically wants 5–15%; below 5% is not worth their time, above 25% is a warning sign for everyone.
What you will accept — and what leaves you with a majority after this round and the next. If a valuation means founders hold 45% after the next round, it is too low; if it means you cannot raise the next round at a higher price, it is too high.

A sanity check that works: would you rather own 80% of a business that raised the money it needs, or 95% of one that didn't?

Instruments, and what each one does to you

Ordinary shares. What founders hold. One class, everyone equal, simplest to document. Required for SEIS/EIS. The default for rounds under £1m.
Preference shares. Get paid back first on an exit or wind-up — sometimes 1× their money, sometimes more — before ordinary shareholders see anything. Common with institutional investors; rare and usually unnecessary at seed. Not SEIS/EIS eligible. If offered, ask for "1× non-participating" and nothing more.
Convertible loan notes. A loan that converts into shares at the next priced round, usually at a discount (15–25%) and sometimes with a valuation cap. Defers the valuation argument, which is why founders like them; the cost is that the discount compounds dilution later. Not SEIS/EIS eligible at issue.
Loan notes. Straight debt: interest, a repayment date, usually security over the company's assets. No dilution. Has to be serviced from cashflow, and the lender ranks ahead of you if it goes wrong.
Advance subscription agreements. The SEIS/EIS-friendly cousin of the convertible: money now, shares at the next round, with a long-stop date. Worth knowing the name.

Five terms to understand before you sign

Pre-emption rights. Existing shareholders get first refusal on new shares in proportion to their holding. Standard and fair. Check the waiver mechanism so one small holder cannot block a round.
Drag-along and tag-along. Drag lets a majority (check the threshold — 75% is common) force minority holders to join a sale on the same terms, so one holder cannot block an exit. Tag lets minorities join a sale the majority has agreed. Both normal. Both should apply to everyone, including the investor.
Founder vesting and leaver provisions. Your shares vest over time (three or four years is common) and unvested shares can be bought back cheaply if you leave. Reasonable in principle — it protects the business and your co-founders. Read the "bad leaver" definition twice: it should cover fraud and gross misconduct, not "resigning".
Consent matters. A list of things the company cannot do without investor consent: issue shares, borrow above a limit, sell the business, change the business. Expect a list; negotiate its length and the threshold. A long list with a low threshold is control, whatever the percentage says.
Warranties. Statements you make about the business that, if untrue, let the investor claim against you. Normal. Make sure they are given by the company, capped at the amount raised, time-limited, and qualified by a disclosure letter in which you write down everything that might be a problem. The disclosure letter is your protection; take it seriously.

A worked example: a £400k round

Bramble raises £400,000 at £1.6m pre-money in SEIS/EIS ordinary shares. Post-money £2.0m; investors get 20%. Founders hold 80%, vesting over four years with 25% vested on day one. Investors get pre-emption, tag and drag at 75%, consent over new share issues and borrowing over £50k, and warranties capped at £400k for eighteen months. Eighteen months later Bramble raises £1.5m at £6m pre-money: the new investors take 20%, everyone else dilutes proportionally, founders hold 64%. That is a healthy cap table, and the reason is that the first round was priced so the second could be.

Before you sign anything

Have a solicitor who does early-stage rounds read the documents. It costs less than the mistake, and a good one will tell you which of the investor's terms are market and which are a try-on. If a clause cannot be explained to you in one sentence, do not sign it. And never accept terms in a conversation — on Find or anywhere else — that are not in the documents; the documents are the deal.

General information about UK practice, not legal or financial advice.

Questions founders ask

"The investor wants 30% for £200k. Is that bad?"

It is a £467k pre-money. Whether that is bad depends on what the traction supports and what it does to you next round: at 30% to one investor now, another 20% next round leaves founders around 50%, and the round after that puts them in a minority. If the business genuinely cannot raise elsewhere, it may be the right deal; if it can, it is a try-on, and a polite "we're at £1m pre, here's why" with the numbers attached is the answer.

"Do I need a shareholders' agreement as well as articles?"

For a round of any size, yes. The articles are public and set the share rights; the shareholders' agreement is private and sets out consent matters, information rights, warranties and what happens when people leave. Investors will expect both; a good solicitor has templates for early-stage rounds and will adapt them for a fixed fee.

"What if the valuation turns out to be wrong?"

It will be — every early-stage valuation is wrong, in one direction or the other. What matters is whether the round was priced so that the next one can happen at a higher price with founders still holding a majority. A slightly low valuation that gets the money in and the business to its milestone beats a high one that stalls the raise.

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