Private Company Discount Rates – the Elephant in the Room
Private company discount rates differ fundamentally from discount rates implied by public-market models. This article explores why.
Ask almost any valuer why the discount rate for a private company is higher than for a listed company. The response is usually the same answer: “Private companies are riskier.”
While that statement maybe true. The real problem is different: “How do we calculate the right discount rate for a private business?”
Why private company discount rates are higher than public company rates
The finance textbooks point us to the Capital Asset Pricing Model (CAPM). CAPM uses beta to measures market risk. However, there is a problem, one that is often not discussed.
This is the problem: CAPM assumes investors are fully diversified. In reality, most private‑company buyers are not diversified.
This is why lack of diversification is the elephant in the private business valuation room. Diversification is rarely discussed. Yet diversification is probably the most important factor explaining why private company discount rates are so much higher than public company discount rates.
Why CAPM fails for private company valuations
CAPM assumes that investors hold broad, diversified portfolios. Those portfolios are so diversified that company‑specific risk does not matter.
In practice, private business buyers invest very differently:
- A small business buyer might put 80–100% of their wealth into one company.
- They cannot diversify away the very risks that beta ignores.
- CAPM therefore understates the true required return for a private business.
As a result, most private‑company investors are not fully undiversified. However, they are often far from the level of diversification assumed by CAPM
Eric Nath and other respected valuers have argued for years that: Private company valuation must be anchored in investor reality and not in abstract capital market theory designed for institutional funds.[i]
For that reason, market‑based sources are important like:
- Pepperdine Private Capital Markets Survey (required returns for banks, mezzanine funds, private equity, venture capital, angels)
- DealStats transaction multiples (what buyers actually pay)
These sources reflect the actual return expectations of the investors who buy private companies.
Market evidence on private company discount rates
The 2025 Pepperdine’s survey of private‑capital market participants reported the following median required private company discount rates.
- Angel investors: 38–35%
- Venture capital: 28–35%
- Private equity: 19–25%
- Mezzanine funds: 17–19%
Against that backdrop, compare this with the cost of equity for public companies (often 8–10%). The implication is stark:
Private-company investors may demand double or triple the return of public-equity investors.
And transaction data supports this result. DealStats typically shows EBITDA multiples between 3× and 5× for private companies. These are far below listed company multiples, which is exactly what you would expect when required returns are 20–35%.
The less diversified the investor, the higher the required return. That is exactly what Damodaran formalised with Total Beta.
Total beta and undiversified private company discount rates
Standard beta measures only market risk. It ignores company-specific risk. Total Beta adjusts for this limitation.
Total beta measures total volatility. Total beta is the returns of the subject company divided by the total volatility of the returns of the market.
For private companies, Total beta answers the question: “If the buyer cannot diversify, what return do they need to justify the investment?”
According to Professor Damodaran’s 2025 industry analysis, the average unlevered beta for the total market was 0.79, but the average unlevered total beta was over 5 times higher at 4.41.
The impact of diversification on discount rates
The table below illustrates how private company discount rates increase once investor diversification is taken into account.
The table shows that on average the return for diversified investors is 8% but for undiversified investors is 23%. This gap is structural. It exists across industries and explains why private company valuations are materially lower than public company valuations.
| Industry | Total Beta | Beta | Cost of Equity (Undiversified) |
Cost of Equity (Diversified) |
|---|---|---|---|---|
| Education | 5.37 | 0.78 | 28% | 8% |
| Engineering / Construction | 4.19 | 0.66 | 22% | 7% |
| Entertainment | 6.44 | 0.99 | 32% | 9% |
| Environmental & Waste Services | 5.09 | 0.86 | 26% | 8% |
| Farming / Agriculture | 3.87 | 0.56 | 21% | 7% |
| Green & Renewable Energy | 3.56 | 0.60 | 20% | 7% |
| Healthcare Support Services | 4.64 | 0.73 | 24% | 7% |
| Information Services | 5.11 | 0.95 | 26% | 8% |
| Retail (Distributors) | 3.75 | 0.62 | 21% | 7% |
| Retail (General) | 5.22 | 1.04 | 27% | 9% |
| Software (System & Application) | 6.88 | 1.31 | 34% | 10% |
| Transportation | 4.36 | 0.71 | 23% | 7% |
| Total Market | 4.41 | 0.79 | 23% | 8% |
Diversification is the elephant in the valuation room
The valuation profession has spent decades debating factors such as size premiums and company-specific risk premiums. Yet the real elephant in the room is: “Who is the marginal investor, and is that investor diversified?”
Private companies are often bought by undiversified, risk‑bearing individuals and private funds. Their required returns are higher. The implied valuations are lower. The market data proves it.
