Choosing the right discount rate is one of the most important drivers in private-company valuation. It reflects the risk, growth expectations, and buyer type involved in a transaction. Below is the recommended rate and how it’s built, along with comparisons to help frame valuation expectations.
Discount Rate for Private Company Valuation:
Primary Recommendation: 20%
Reasonable Range: 18–22%
Quick Reference Guide:
| Buyer Type | Discount Rate | Results In |
|---|---|---|
| Strategic Buyer | 15-18% | Highest valuation |
| Financial Buyer (PE) | 18-22% | Market valuation |
| Individual Buyer | 20-25% | Conservative valuation |
How the Discount Rate Is Built:
Build-Up Method = 19%:
- Risk-Free Rate: 4.5%
- Equity Risk Premium: 6.0%
- Size Premium: 2.5%
- Company-Specific Risk: 3.0%
- Illiquidity Premium: 3.0%
- Total: 19.0%
CAPM Method = 21%:
- Risk-Free Rate: 4.5%
- Beta × Market Premium: 8.5% (Beta 1.42)
- Company-Specific Risk: 3.0%
- Illiquidity Premium: 3.0%
- Size Premium: 2.0%
- Total: 21.0%
Impact on Valuation Multiples
Using a 20% discount rate vs. alternatives (assuming $1M EBITDA, 3% growth):
| Discount Rate | Valuation Multiple | Enterprise Value |
|---|---|---|
| 16% | 7.92x | $7.92M |
| 18% | 6.87x | $6.87M |
| 20% | 6.06x | $6.06M |
| 22% | 5.42x | $5.42M |
| 25% | 4.68x | $4.68M |
Key Insight: Each 2% change in discount rate changes valuation by ~10-15%
When to Adjust the Base 20% Rate:
INCREASE to 22-25% if:
- Customer concentration (>25% from one customer)
- Key person dependency
- Inconsistent cash flows
- Declining industry
- Weak financial controls
DECREASE to 16-18% if:
- Diversified customer base
- Strong management team
- Recurring revenue model
- Growing industry
- Strategic buyer with synergies
Market Comparison by Company Size:
| Company Size | Discount Rate | Typical EBITDA Multiple |
|---|---|---|
| Micro-cap (<$5M EBITDA) | 22-28% | 2.5x - 4.5x |
| Lower Mid ($5-25M) | 18-24% | 4.0x - 6.5x |
| Middle Market ($25-100M) | 15-20% | 6.0x - 8.5x |
| Upper Mid (>$100M) | 12-18% | 7.5x - 10.0x |
Bottom Line:
Based on your 25.5% volatility and 18-20% required return, use:
✓ 20% as your base discount rate for DCF valuations
✓ Test sensitivity at 18% and 22% to show valuation range
✓ Adjust based on:
- Buyer type (strategic = lower, individual = higher)
- Company-specific strengths/weaknesses
- Transaction structure and terms
This 20% rate properly accounts for the market risk, illiquidity, and company-specific factors inherent in private company transactions, and aligns with typical middle-market M&A practice. Keep this in mind as you build your firms value. The components here are KEY Drivers if you ever plan on selling.
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