The number in the middle that nobody can source
Every risk that supposedly lowers your business value passes through one figure in the discount rate. The profession's own guidance says there is no data source for it.
Ask why a valuation came out low and you get a list of reasons. One customer is too big. The owner does the selling. The accounts are compiled rather than audited. Each of those sounds like an observation about your business.
Follow the arithmetic and every one of them enters the calculation at the same place: a single percentage added to the discount rate. The discount rate is the annual return a buyer wants for taking on the risk of owning your business, and the higher it is, the less your future profits are worth today.
Three percentage points added there is not a rounding error. Take a business earning €400,000 a year, valued the simple way, as that stream of earnings continuing indefinitely. At a discount rate of 18% it is worth about €2,222,000. At 21% it is worth about €1,905,000. Three points, decided by one person's judgement, is €317,000.
That percentage has a name: the company-specific risk premium. It is the most consequential number in most SME valuations and the least documented.
How the number is built
Most private company valuations use the build-up method, which is exactly what it sounds like. You start with the return available on a government bond, then add a percentage for each extra risk a buyer is taking on by owning your business instead. The total is the discount rate.
| Component | Where it comes from |
|---|---|
| Risk-free rate | Government bond yields. Observable. |
| Equity risk premium | Long-run market data. Published, and debated. |
| Size premium | Published portfolios of listed companies by size. |
| Industry premium | Sometimes included, from published industry data. |
| Company-specific risk premium | The analyst. |
The first four have sources you can look up and argue with. The fifth is where owner dependence, customer concentration, key supplier risk, thin management and everything else specific to your business gets converted into a number.
The profession says so itself
This is not an outside critique. It is in the published guidance of the National Association of Certified Valuators and Analysts, in an article on best practice for estimating exactly this figure:
there is no easily identifiable data source that analysts can access to specifically quantify that particular return component
The same guidance states that the estimate "is a matter of the analyst's professional judgment."
That is a fair and honest description. It is also a description of an input that cannot be checked, sitting inside a calculation whose output is presented to two decimal places.
The courts have been blunter
Delaware's Court of Chancery hears more corporate valuation disputes than any court in the world, and it has developed a settled view.
In In re Sunbelt Beverage Corp. in 2010, the court wrote that "proponents of a company-specific risk premium thus not only bear a burden of proof but also must overcome some level of baseline skepticism." It rejected the premium in that case because the risks offered applied across the whole industry rather than to the company, which is the same double-counting problem covered further down.
In Solar Cells, Inc. v. True North Partners in 2002, the court was concerned that subjective measures of this kind could "smuggle improper risk assumptions into the discount rate so as to affect dramatically the expert's ultimate opinion on value."
In Hintmann v. Fred Weber, Inc. in 1998, the court required experts to demonstrate how claimed risk factors "translated into extra risk," a standard that Kroll's own survey of the case law describes as frequently unmet.
In Onti v. Integra Bank, the court accepted 1.7% where the expert had proposed 3.4%, halving it for insufficient evidentiary support.
The spread is the story
There is a serious attempt to derive company-specific risk from data rather than judgement. Kroll's Risk Premium Report sorts companies into groups by how thin their profit margins are and by how much those margins and returns jump about from year to year, and shows that thinner and jumpier went with higher returns demanded by investors. That is a genuine empirical foundation and the right direction of travel.
But look at what happens even inside a well-documented framework. The American Society of Appraisers publishes a worked example for a single hypothetical company using three accepted methods from the same source data:
- Size study, portfolio
- 15.79%
- cost of equity for the same company
- Smoothed premium regression
- 17.19%
- same company, same source
- Modified CAPM regression
- 18.03%
- same company, same source
Two and a quarter percentage points of spread on the same business, before anyone has added a judgement-based company-specific premium at all.
Valued as a continuing stream of earnings, 15.79% works out at 6.3 times earnings and 18.03% at 5.5 times. Read that in the direction that matters to a seller: the lowest of the three methods values the business about 14% higher than the highest. Same company, same source data, three methods all considered acceptable.
Why this is the keystone
Every claim you read about what lowers an SME's value runs through this step. Customer concentration, owner dependence, cost structure, supplier risk: none of them has a published effect on transaction multiples. What they have is a plausible route into the company-specific risk premium, and the profession's own standard-setter says that premium has no data source.
That does not make the risks fake. A business with one customer at 40% of revenue genuinely is riskier, and a buyer will genuinely pay less for it. It means the specific number attached to that risk in a valuation report is a judgement wearing the clothes of a calculation. We looked for the evidence behind two of those risks, customer concentration and owner dependence, and in both cases found a direction without a magnitude.
What to do when you receive one
Ask for the components separately. A discount rate should arrive as a stack, not a total. If the company-specific premium is not shown on its own line, it is not being disclosed.
Ask which risks are already counted elsewhere. Size is in the size premium. Industry risk is in the industry premium. If they reappear in the company-specific premium, they are being charged twice, and that is precisely what Delaware rejected in Sunbelt.
Ask what would change it. A risk premium that no achievable change would reduce is not a risk assessment, it is a verdict. If the answer is that two more years of trading history and a second signatory would move it, you have a plan. If there is no answer, ask why the number is in the report.
Ask for the sensitivity. Two percentage points on the discount rate is worth more than most of the operational improvements you could make in a year. If a report does not show you the value at a range of discount rates, it is presenting the most uncertain input as though it were the most certain.
What this does not tell you
None of this means valuations are worthless or that valuers are careless. The build-up method is the best available tool for a business with no market price, and a thoughtful analyst applying judgement transparently is doing legitimate work.
It also does not give you a better number. There is no data source we can point you at that fixes this, because if there were, NACVA would have pointed at it.
What it gives you is the right question. Not "what is my business worth," which nobody can answer to a decimal, but "which assumptions is this number resting on, and which of them do I disagree with." That is a conversation you can win.
Sources
- Robert Reilly and Connor Thurman, "Best Practices for Estimating the Company-Specific Risk Premium," QuickRead, published by the National Association of Certified Valuators and Analysts, 9 December 2020. Source of both quoted passages. https://quickreadbuzz.com/2020/12/09/business-valuation-reilly-thurman-best-practices-for-estimating-the-company-specific-risk-premium/
- Kroll, "From the Parlor to the Courtroom: The Use of Company-Specific Risk Premium in Valuations." Source of the Delaware case survey, including In re Sunbelt Beverage Corp. (2010), Solar Cells, Inc. v. True North Partners (2002), Hintmann v. Fred Weber, Inc. (1998) and Onti v. Integra Bank, and of the description of the Risk Premium Report Risk Study. https://www.kroll.com/en/publications/expert-services/from-the-parlor-to-the-courtroom-the-use-of-company-specific-risk-premium-in-valuations
- American Society of Appraisers, Valuing a Business, chapter 11, "Using Risk Premium Report Size Study Data." Source of the worked example producing 15.79%, 17.19% and 18.03% for the same company by three accepted methods. https://www.appraisers.org/docs/default-source/6.-publications/vab6/ch-11-using-risk-premium-report-size-study-data.pdf
- Kroll, Cost of Capital Navigator, formerly the Duff & Phelps Valuation Handbook, for the framework within which these premia are published. https://www.kroll.com/en/tools-and-platforms/cost-of-capital/us-cost-of-capital
A note on figures we did not publish
The Risk Premium Report's Risk Study exhibits contain the numbers that would let an analyst derive a company-specific premium from data rather than judgement. Those exhibits are behind a subscription and we could not obtain them, so this article does not quote any Risk Study value second-hand. That absence is part of the point: the most empirically grounded component of this calculation is also the one you cannot check without paying for it.