Understanding discount rate: definition, formulas, importance for negotiation and useful sources to find the right one for the valuation of your company or startup. Read more on: https://www.equidam.com/the-discount-rate-in-the-valuation-of-a-startup/ Curious about your discount rate and valuation? Sign up for free at at https://www.equidam.com/

1. Understanding
DISCOUNT RATE
for the valuation of your
company or startup

2. ENTREPRENEURS HAVE TO CONVINCE POTENTIAL INVESTORS THAT:
>
REQUIRED RETURNDISCOUNT RATE
The compensation for the
risk the investor is taking
The value growth the company needs
to achieve to justify the initial
investment.

3. A coefficient used to calculate today’s value of future cash flows,
accounting for the uncertainty (Risk) of not receiving all or part of the future cash flows.
WHAT IS THE DISCOUNT RATE?
Risk Discount Rate=

4. Receiving $100 today is not equal
to receiving $100 tomorrow
WHY DO WE NEED THE DISCOUNT RATE?
INFLATION RISK*
The value of money decreases with time at
a macro level
The money today is certain, while in the
future anything could happen
*For the application of discount rate for valuation, we will mostly focus on this factor.

5. The value of $100 today is not equal
to $100 tomorrow
IF THE RISK IS NOT EQUAL

6. TODAY’S VALUE OF $100 RECEIVED IN 1 YEAR IS
$100 (1+discount rate)n
Discounted value =
where n is the amount of years in the future
In this example, one

7. IN THE SAME WAY FOR A GENERAL CASH FLOW
Current cash flow (1+discount rate)n
EXAMPLES
Discounted value =
Value of $10,000 in 1 year: $10,000 / (1+0,10*) = $9,090.90
Value of $10,000 in 2 years: $10,000 / (1+0,10*)2 = $8,264.46
where n is the amount of years in the future
*Assumption: discount rate of 10%

8. A COMPANY IS JUST A SERIES OF CASH FLOWS
Future cash flow at year n (1+discount rate)n
Company value = sum of:
For infinite n years

9. HOW TO ESTIMATE THE DISCOUNT RATE

10. The money could be invested somewhere else.
If another opportunity has
less risk and same return
or
same risk and more return
the money will go to that one.
In equilibrium
any opportunity must have a similar risk/return ratio.
ANY INVESTMENT HAS AN OPPORTUNITY COST

11. Weighted Average Cost of Capital (WACC)
The WACC estimates risk of the company comparing it to risk and returns of the market.
It takes into account equity and debt as a sources of capital and weights them based on their
% on the total financing of the company
INTRODUCING THE
+% of financing that is equity Cost of Equity
* % of financing that is debt Cost of Debt*

12. +% of financing that is equity Cost of Equity
* % of financing that is debt Cost of Debt
*
However, being the debt of private companies and start-ups (when present) not tradable,
WACC can be assumed equal to the cost of equity, often calculated with the
Capital Asset Pricing Model – CAPM – formula

13. Capital Asset Pricing Model – CAPM – formula
The theoretical rate of return of an investment with “no risk” of financial loss.
Usually well performing government bond are considered for this element (10
years Treasuries for US and EU Bonds for EU)
Cost of Equity = Risk free rate + beta Market risk premium
*

14. Capital Asset Pricing Model – CAPM – formula
10 years Treasuries returns today the 2.3% per year
See up to date data at: http://data.cnbc.com/quotes/US10Y
See EU Bonds here:
http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=143.FM.M.U2.EUR.4F.BB.
U2_10Y.YLD
Cost of Equity = 2.3% + beta Market risk premium
*

15. Capital Asset Pricing Model – CAPM – formula
Cost of Equity = 2.3% + beta Market risk premium
*
The beta indicates how the industry of the company relates to the market in terms of risk.
If the industry is more volatile than the market, then the risk but also the expected returns are
higher, and vice versa.

16. Capital Asset Pricing Model – CAPM – formula
Cost of Equity = 2.3% + 1.34 Market risk premium
*
From the list of betas of NYU Professor Aswath Damodaran:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/Betas.html
we can get a sample beta for the Software (Internet) Industry of 1.34, other industries are
also available at the link

17. Capital Asset Pricing Model – CAPM – formula
Cost of Equity = 2.3% + 1.34
Market expected
returns( )- Risk free rate
This is the premium return required by investors to take the risk on the public market:
Market risk premium
*

18. Capital Asset Pricing Model – CAPM – formula
Cost of Equity = 2.3% + 1.34
We can use the Market Risk Premium for the U.S. Market of 6.25%
6.25%
*
Again from NYU Professor Aswath Damodaran
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html

19. CAPM RESULTING DISCOUNT RATE
10.67% = 2.3% + 1.34
By just crunching the numbers we get to
a yearly discount rate of 10.67%
6.25%
*
DISCLAIMER: Startups and early stage companies often carry other risks and sometimes a percentage is
added to the WACC based on the experience of the valuator.
On Equidam, discount rates are estimated by taking into account also number of employees, profitability and
other variables and they are always up to date.

20. FOR STARTUPS and SME,
THIS IS NOT ENOUGH TO TAKE INTO ACCOUNT ALL THE
RISKS INVOLVED.
Additional factors such as
Failure rate and
Illiquidity
should be added

21. Failure rate
The probability of failure of startups and small companies is generally higher than the one of
larger companies. For this reason, an additional discount or and increased discount should be
considered when valuing these types of companies. Failure rates for small companies can be
retrieved by the Statistics Bureau of your country.
Illiquidity discount
Private companies have an additional difference when compared to public ones. The investment
an investor makes is illiquid. In other words, selling the participation is going to take time, and
could bring the price down. This additional risk has to be compensated with an additional discount
or added to other discount factors.

22. DISCOUNT RATE IN NEGOTIATIONS

23. WHAT ARE YOU REQUIRED TO KNOW, THEN?
No-one expects you to be a financial expert.
What you need to know is that the discount rate reflects the risk and lowers the current price so that
investors can invest and potentially receive a fair return.
There is no need to compute every single formula, however understanding the
BASIC FINANCIAL PRINCIPLES will give you and edge and ensure the right outcomes of your
investment discussions.
DISCLAIMER:
Equidam automatically collects and applies the most suitable discount rate, so that you can avoid computing the formulas.

24. Our role, as entrepreneurs, is to give investors the information that allows them to best
estimate the risk and be confident they are making the right choices.
Investors do not have the full picture when they try to asses the company’s risk, simply
because they are not in it on a daily basis.“

25. YOU NEED TO CONVINCE POTENTIAL INVESTORS THAT:
>
REQUIRED RETURNDISCOUNT RATE
The compensation for the
risk the investor is taking
The value growth the company needs
to achieve to justify the initial
investment.

26. YOU CAN DO THIS BY:
INCREASING PERCEIVED
RETURN
REDUCING
PERCEIVED RISK
As stated, investors know less about the company than you. Make sure your transfer your knowledge on the
future risks, the risks that are not there, and the future potential

27. Thank you!
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