4. Handling Additional Risks

We have seen that investing in a startup company typically entails additional risks compared to investing in a more established firm. Examples of such additional risks are:

  • More pronounced technical challenges
  • Funding problems
  • Survival
  • Poor diversification of the owners
  • Illiquidity of the investment (inability to sell over a prolonged period of time)
  • etc.

The question is how to incorporate these additional risks in the valuation of the startup firm. Practitioners usually choose between one of the two following approaches:

  • Add additional risk premia to the cost of capital to capitalize future cash flows
  • Use the cost of capital for established firms (see previous section) and then apply discounts to the resulting "normal" valuation to reflect the value implications of the additional risks.


The following two sub-sections discuss these methods in more detail. In doing so, we look at a hypothetical firm that is expected to generate the following cash flow profile over the next 7 years (in thousands). For simplicity, we assume that the firm ceases to exist after 7 years.


 (thousands) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Free Cash Flow -1'000 -1'000 500 1'000 2'000 3'000 5'000


We also assume that comparable listed firms operate at a cost of capital of 10% (WACC). Consequently, under the assumption that our firm has the same risk profile as its comparable listed firms, the DCF-value of the company is 4.8 million:


DCF-Value with Benchmark Risk = \( -\frac{1'000}{1.1} - \frac{1'000}{1.1^2} + ... + \frac{5'000}{1.1^7} \) = 4'824.


Now let us consider how this valuation changes when we incorporate the specific risks of a startup company.