Some appraisers are not comfortable using public market data when estimating the cost of capital for a private company. While this method is justified by valuation standards and IRS Revenue Ruling 59-60, many assumptions and adjustments need to be made to convert data from actively traded stocks into proxies for private-company valuation. An alternative analysis is available that is based on an ongoing survey of expected rates of return of providers in the private capital market, which has recently been updated.
Latest report: For the “2019 Private Capital Markets Report,” researchers at the Pepperdine University Graziadio Business School asked private capital market players what returns they project. The players are divided into six segments aligned with the major institutional arms of the private investment world, each with different return, investment, and research characteristics. The project was originally launched in 2007. The median cost of capital rates determined by the latest survey appear in the table below. The full report contains much more detail on each type of funding.
| Type of Private Capital Funding | Pepperdine Median Rate of Return (Range) |
|---|---|
| Banks | 5.0%-6.3% |
| Asset-based lenders | 4.0%-15.0% |
| Mezzanine financers | 13.0%-15.0% |
| Private equity groups | 21.0%-37.0% |
| Venture capital investors | 28.0%-38.0% |
| Angel investors | 28.0%-38.0% |
Idea in action: During a recent webinar, business appraiser David Coffman (Business Valuations & Strategies PC) explained how he uses the Pepperdine survey for estimating the cost of capital for owner-operated small businesses. To the median expected return from the survey, he adds a company-specific risk adjustment. He has used this method in hundreds of valuations without being subject to any significant challenges.
Of course, BUM and CAPM are not likely to disappear from the valuation scene any time soon, but that doesn’t mean that experts should not consider adding a private capital markets analysis to their toolbox.