CHAPTER 6
Applicable Discounts for Early Stage Companies
I’m always amazed at how much time and effort is expended by valuation professionals arguing about discount rates for their discounted cash flows (DCFs), volatility and other inputs for their option-pricing models (OPMs), and probabilities in the scenario approach in their valuations of early stage companies. Yet when all is said and done, the application of discounts to the aggregate values determined under whatever valuation approach was utilized may surge upward to 70 or 80 percent off the aggregate common equity value. The picture that comes to mind is a group of neurosurgeons performing an intricate procedure only to have an orderly walk in during the operation and wash everything down with a fire hose. Well, maybe it isn’t that bad, but the “blunt instrument” application of discounts typically eliminates a significant portion of common equity value at the minority, non-marketable level.
Think about it: If a sensitivity analysis is performed on a selected discount rate or volatility percentage and the resulting valuation outputs differ by 40 percent or more, deeper analysis would be warranted to narrow, or at least refine, such a large gap. Nonetheless, large discounts of 40 percent or more are commonly applied, many times with little support other than passing reference to traditional discount studies. I’m not saying large discounts aren’t warranted for early stage companies. On the contrary; I have beaten the “higher ...

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