“I need to be compensated for the risk I’m taking”
“I want a larger return than that”
These are typically statements that you would hear from a VC or an angel investor. But, what do they mean? What’s the link between discount rates and required returns? And how are these related with the amount of equity you will have to grant them to seal the deal? In this article Stefani from Equidam will try to explain what discount rate means for the valuation of your startup.
The value of one €uro today is not comparable to the same €uro in a future period. This is why the Discounted Cash Flows method (DCF) is one of the most used in the valuation of companies in general. The discount rate applied in this method is higher than the risk free rate though. The Risk Free Rate is indeed observable in the market but can be applied only to those streams of cash flows which are expected to manifest in the future with certainty. That doesn’t include startups. The usual benchmark for Risk Free Rate- cases, in Europe, is the return on the German Bund (bond), whose coupons and final repayment are considered to be 100% sure. In financial terms, the implied correlation of this type of investments with the overall economic conditions is a null value. Whatever will happen, the cash flows are guaranteed.