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Private Company Cost of Equity (Build-Up) Calculator

Calculate the Cost of Equity (Ke) for privately held businesses using the Build-Up Method. Stack risk-free rate, equity risk premium, size premium, and company-specific risk to derive a discount rate without requiring Beta, for use in DCF valuations, M&A deals, and business appraisals.

The Equity Risk Stack

1
%
Baseline 20-Year Treasury Yield.
+
%
General stock market danger premium.
+
%
Extra yield due to private illiquidity and mortal risk.
+
%
Subjective underwriter "Gut Check" for bad management.

WACC Capital Structure (Optional Synthesis)

%
x
Blend your calculated equity cost against corporate debt weight to finalize Enterprise Value discount rates.

Cost of Equity (COE)

15.25%
Absolute yield expectation.
Accumulated Danger
+11.00%
Base Sovereign
+4.25%

Private Enterprise WACC

12.83%
Blended calculation using 0.50x D/E Leverage.

Capital Synthesis Weighting

Corporate Equity Weight (E/V):66.7%
Corporate Debt Weight (D/V):33.3%
Valuation Modeling: Input the 12.83% WACC directly into your DCF (Discounted Cash Flow) mathematical model to accurately haircut future private company revenues back to present-day acquisition value.
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What is The Build-Up Method?

The Build-Up Method is the foundational technique used by Private Equity and Business Valuators to determine the Cost of Equity ($K_e$) for privately held businesses. Unlike public companies, private companies don't have a stock price, meaning you cannot calculate their "Beta" for the CAPM equation. Instead, the Build-Up Method mathematically "stacks" individual risk premiums on top of each other.

Mathematical Foundation

COE=Rf+ERP+RPs+RPuCOE = R_f + ERP + RP_s + RP_u
RfR_f= The Risk-Free Rate (usually the 20-Year US Treasury yield).
ERPERP= Equity Risk Premium (the standard extra return demanded for investing in the stock market instead of bonds).
RPsRP_s= Size Premium (the extra return demanded because small companies fail much faster than large ones).
RPuRP_u= Company-Specific Premium (the subjective risk of the exact company you are buying: single supplier risk, bad management, lack of IP, etc).

Laws & Principles

  • The Absence of Beta: In CAPM, systemic risk is modeled via Beta $eta$. The Build-Up Method completely throws Beta out the window (effectively assuming $eta = 1.0$) and relies entirely on raw percentage stacking.
  • The Discount Rate: This Cost of Equity is fundamentally the Discount Rate you use to pull the company's future Cash Flows back to Present Value. A higher COE vastly lowers the valuation of the business.
  • Synthesizing WACC: Once you establish what the Equity costs ($COE$), you blend it with what their Debt costs (the interest rate on their company loans) using the Debt-to-Equity ratio to build their final Weighted Average Cost of Capital (WACC).

Step-by-Step Example Walkthrough

" You are attempting to value a local private manufacturing company. The 20-Year T-Bond yields 4.25%. The standard market ERP is 5.50%. Because they are small, Duff & Phelps data suggests a 3.50% Size Premium. The owner tells you 40% of their revenue comes from exactly 1 client, so you add a steep 2.0% Company-Specific Premium. "

  1. 1. Base Rate: 4.25% (Risk-Free).
  2. 2. Add ERP: 4.25% + 5.50% = 9.75%.
  3. 3. Add Size Premium: 9.75% + 3.50% = 13.25%.
  4. 4. Add Specific Risk: 13.25% + 2.00% = 15.25% (Total COE).
  5. 5. They have a 0.50x D/E Ratio and their bank loan costs 8%.
  6. 6. WACC = (0.666 * 15.25%) + (0.333 * 8.0%) = 12.83%.
Final Result: Before buying this private business, you mathematically must demand at least a 15.25% return on your equity to justify the compounded dangers of its size and concentration.

What is The Build-Up Method: Deriving Cost of Equity for Private Companies Without Beta?

The Build-Up Method (BUM) is the standard approach used by business valuators (ASA, CVA, ABV credentials), M&A advisors, and lenders to estimate the Cost of Equity (Ke) for privately held companies that have no publicly traded stock and therefore no observable Beta. Unlike CAPM, which requires Beta from market price data, the Build-Up Method constructs Ke by adding a series of risk premiums on top of a risk-free rate. Each premium compensates investors for a specific, identifiable category of risk. The sum represents the minimum return a rational investor would require to invest equity capital in the subject company given all identifiable risks.

Mathematical Foundation

Build-Up Cost of Equity
Ke=Rf+ERP+SP+CSRPK_e = R_f + ERP + SP + CSRP
RfR_f= Risk-Free Rate — the yield on a default-free government security with a maturity matching the investment horizon. Standard US practice: use the 20-year US Treasury bond yield (not the 10-year, which has reinvestment risk mismatch for long-term business cash flows). Current range: 4.0–5.5% (2024–2025). The risk-free rate represents the minimum return required for any investment — the starting point before adding any risk premiums.
ERPERP= Equity Risk Premium — the additional return investors demand for bearing systematic market risk (the risk of investing in equities generally, not in any specific company). Published annually by Duff & Phelps / Kroll in the Valuation Handbook. Typical long-run historical ERP in the US: 5.0–7.5%. As of 2024: Duff & Phelps supply-side ERP estimate = 5.5%. Important: the ERP in Build-Up is NOT multiplied by Beta (unlike CAPM where you use Beta × ERP). In Build-Up, the full ERP is added directly, implicitly assuming the subject company has Beta ≈ 1.0. For companies with significantly lower or higher systematic risk than the market: adjust ERP by industry Beta factor.
SPSP= Size Premium — the empirically documented additional return that smaller-capitalization equities have historically provided above what their Beta would predict. Published by Duff & Phelps / Kroll in the CRSP Decile portfolios. Rationale: small companies face higher liquidity risk, less access to capital markets, narrower customer/product diversification, and greater sensitivity to credit conditions. Typical ranges: Micro-cap (10th decile: market cap <$500M) = 3.0–6.5%. Small-cap (9th decile: $500M–$2B) = 1.5–3.0%. Mid-cap: 0.5–1.5%. Large-cap: near 0%. For private companies: use the decile corresponding to your subject company’s estimated equity value.
CSRPCSRP= Company-Specific Risk Premium — a qualitative-to-quantitative premium for idiosyncratic risks unique to the subject company that are NOT captured by ERP or SP. This is the most subjective and controversial component. Typical factors considered: (1) Key person dependence — does the business depend on 1–2 individuals? (2) Customer concentration — does one customer represent >25% of revenue? (3) Geographic concentration — single-location vs. diversified operations. (4) Supplier concentration — single-source supplier risk. (5) Litigation or regulatory exposure. (6) Thin management depth. (7) Industry cyclicality above market. Typical CSRP range: 0–8%, with most business valuations applying 1–5%.

Laws & Principles

  • Always use the 20-year Treasury as your risk-free rate baseline: Business valuations under IRS Revenue Ruling 59-60 and ASC 820 (Fair Value Measurement) require matching the investment horizon of the risk-free rate to the economic life of the subject company's cash flows. Private businesses typically have perpetuity or very long-horizon cash flows, making the 20-year Treasury (not 10-year) the appropriate benchmark. Using the 10-year Treasury in Build-Up understates the risk-free rate by 0.2–0.5% in normal yield curve conditions, systematically producing valuations that are 10–20% too high (lower discount rate → higher present value).
  • The full ERP is added without Beta because Build-Up implicitly assumes Beta = 1.0: CAPM uses (Beta × ERP) to adjust for systematic risk relative to the market. Build-Up adds the full ERP directly — which is mathematically equivalent to assuming Beta = 1.0. This assumption is defensible for many private companies with broad market exposure. However, for highly cyclical businesses (construction, mining, oil services: Beta > 1.5) or counter-cyclical businesses (healthcare, utilities: Beta < 0.7): multiply ERP by an industry Beta factor from Damodaran's industry averages before adding it to the Build-Up stack. Not adjusting for a 1.8 Beta in a cyclical business understates Ke by 3–5 percentage points.
  • Company-Specific Risk Premium (CSRP) must be supportable and documented: The CSRP is the most litigated component in business valuation disputes (IRS Tax Court, divorce proceedings, estate tax challenges). Simply applying a 5% CSRP and moving on is not defensible. Best practice: document each CSRP factor as a line-item adjustment with specific evidence. Example: 'Key Person Risk +2.0%: CEO John Smith controls 100% of client relationships and has no employment agreement or succession plan.' Reasonable CSRP for well-managed, diversified small businesses: 1–2%. For single-person consulting firms or businesses with dominant customer concentration: 4–8%.
  • Build-Up produces higher Ke than CAPM for most private companies — and this is intentional: Private company equity carries a liquidity discount that public market CAPM doesn't price. Investors in private equity cannot sell their stake on an exchange; they must find a willing buyer through a negotiated transaction. This illiquidity requires a higher return. The combination of size premium + CSRP typically adds 4–12% above CAPM for private companies. A Build-Up Ke of 18–25% for a small private business is not unusual — and applying a public-company CAPM Ke of 10–12% to the same business produces a grossly inflated valuation. Many failed deal underwritings and tax disputes arise from improperly applying public market discount rates to private company cash flows.

Step-by-Step Example Walkthrough

" A business valuator is determining the Cost of Equity for a private manufacturing company with ~$3M in EBITDA, located in a single facility in the Midwest, with one customer representing 35% of revenue and a 65-year-old CEO who is the primary customer relationship manager. "

  1. 1. Risk-Free Rate (R_f): 20-year Treasury yield = 4.50%.
  2. 2. Equity Risk Premium (ERP): Duff & Phelps supply-side ERP = 5.50%. No Beta adjustment (assumed ≈ 1.0 for manufacturing). Add: +5.50%.
  3. 3. Size Premium (SP): Target company estimated equity value ~$8M — this falls in the 10th (micro-cap) CRSP decile at ~95th percentile of private businesses. SP = +5.00%.
  4. 4. Company-Specific Risk Premium (CSRP): Key person (CEO, 65, no succession plan): +2.5%. Single customer >25% revenue: +1.5%. Single-facility geographic concentration: +0.5%. Total CSRP = +4.50%.
  5. 5. Sum all components: Ke = 4.50 + 5.50 + 5.00 + 4.50 = 19.50%.
Final Result: Cost of Equity Ke = 19.50%. Applied to the company's after-tax free cash flows in a DCF model, this discount rate reflects the specific risk profile of this business. Removing any CSRP factor reduces Ke proportionally: eliminating customer concentration risk drops Ke to 18.0% and increases the estimated business value by approximately 10%.

Quick Answer: How do I calculate Cost of Equity for a private company without Beta?

Use the Build-Up Method: Ke = Rf + ERP + SP + CSRP. Stack: risk-free rate (20-yr Treasury, ~4.5%) + equity risk premium (Duff & Phelps, ~5.5%) + size premium (CRSP decile by market cap, 2–6%) + company-specific risk premium (0–8%). Example: small manufacturer: 4.5% + 5.5% + 5.0% + 4.5% = Ke = 19.5%. This discount rate is then used in a DCF valuation or to calculate WACC. Build-Up produces higher Ke than CAPM for private companies because it explicitly prices illiquidity and idiosyncratic risk that public market data doesn’t capture.

Build-Up Method Component Reference by Company Type

Typical ranges as of 2024–2025 using Duff & Phelps / Kroll data. Actual values require current Valuation Handbook data for the appraisal date.

Company Profile Rf ERP SP CSRP Total Ke
Large private ($50M+ equity)4.50%5.50%1.50%1.00%12.5%
Mid-market ($10M–$50M equity)4.50%5.50%3.00%2.00%15.0%
Small business (<$10M equity)4.50%5.50%5.00%3.00%18.0%
Micro / owner-dependent4.50%5.50%6.50%5.00%21.5%
Distressed / high-risk4.50%5.50%6.50%8.00%24.5%
These are illustrative ranges only. Current ERP and Size Premiums must be sourced from the Duff & Phelps / Kroll Valuation Handbook for the specific valuation date. The Valuations Handbook is updated annually and premium values can shift 0.5–1.5% between editions. Always cite the specific Handbook edition and date of value in any written appraisal.

Pro Tips & Common Build-Up COE Mistakes

Do This

  • ✓Document each CSRP component as a line-item adjustment with specific evidence — the CSRP is the most litigated element in IRS Tax Court valuation disputes. A CSRP entry of “+3% for business risk” without documentation is indefensible in tax court or a contested M&A appraisal. Best practice: itemize every factor: “Key person +2.0% (CEO is sole business development officer, age 65, no succession plan); Customer concentration +1.5% (top 2 customers = 48% revenue, no LTAs). Total CSRP = 3.5%.” IRS Revenue Procedure 59-60 specifically requires listing the factors that affect value — this is your audit trail.
  • ✓Apply an industry Beta adjustment to the ERP for highly cyclical or counter-cyclical businesses. Build-Up implicitly assumes Beta = 1.0. But a construction company (industry Beta ≈ 1.6) should use ERP × 1.6, not ERP alone. From Damodaran’s January 2024 Industry Betas: Engineering/Construction = 1.27, Oil & Gas (integrated) = 1.21, Advertising = 1.78, Tobacco = 0.55, Healthcare Facilities = 0.68. For a construction company build-up: instead of adding 5.5% ERP, add 5.5% × 1.27 = 6.99% — a 1.5 percentage point difference that reduces business value by 8–12% in a DCF.

Avoid This

  • ✗Don’t use the 10-year Treasury as your risk-free rate in a Build-Up for a going-concern business — the 20-year is the correct benchmark and using the 10-year systematically inflates the valuation. A 10-year Treasury at 4.2% vs a 20-year at 4.7% is a 0.5% difference in Rf. Applied to a business generating $500K/year in free cash flow: a 10-year-derived Ke of 17.5% yields a DCF value of $500K / 0.175 = $2.857M. A 20-year-derived Ke of 18.0% yields $500K / 0.180 = $2.778M. That 0.5% Rf selection error = $79,000 overvaluation without changing a single assumption about the business. In a $10M business, this error compounds to a $200K–$400K systematic overstatement.
  • ✗Don’t apply a public company CAPM discount rate (typically 8–12%) to a small private company’s cash flows — you will produce a valuation 30–50% above fair market value. Public-company CAPM assumes liquid, tradeable equity. Private company equity is illiquid by definition. The size premium + CSRP in Build-Up explicitly compensate for this. A CAPM Ke of 11% applied to $300K/year FCF = $300K / 0.11 = $2.727M. A Build-Up Ke of 20% for the same small business = $300K / 0.20 = $1.500M. The 9-point discount rate difference produces an 82% valuation gap. Many M&A advisors and buyers using CAPM-derived rates on small private businesses are systematically overpaying — and then confused when post-acquisition returns disappoint.

Frequently Asked Questions

Why does the Build-Up Method not use Beta?

Beta is calculated from the covariance of a stock’s price returns with the market portfolio — which requires observable market prices. Private companies have no market-traded stock, so no Beta can be observed or calculated. Rather than estimating Beta by proxy (using comparable public company Betas and “unlevering/relevering” for capital structure differences, which introduces substantial estimation error), the Build-Up Method bypasses Beta entirely. It adds the full Equity Risk Premium (ERP) directly — which is equivalent to assuming Beta = 1.0 for the subject company. This assumption is then adjusted by: (1) the size premium (smaller companies empirically have higher risk-adjusted returns), and (2) the company-specific risk premium (idiosyncratic risks not captured by market data). The result captures the same risk dimensions as CAPM but without requiring unobservable Beta estimates.

Where do I get current ERP and Size Premium data for Build-Up?

The authoritative source is the Duff & Phelps / Kroll Valuation Handbook — U.S. Guide to Cost of Capital, published annually. It provides: (1) ERP estimates using both historical (Ibbotson) and supply-side (earnings growth) methodologies. (2) Size premiums by CRSP market-cap decile (10 deciles from largest to smallest). (3) Industry risk premiums by SIC code (for the industry Beta adjustment). The handbook is subscription-based and typically used by CVA, ABV, and ASA-credentialed appraisers. For practitioners without access: Damodaran’s free website (pages.stern.nyu.edu/~adamodar/) provides annual ERP estimates and industry Betas. As of January 2024: Damodaran’s implied ERP for the US market = 4.6%; Duff & Phelps supply-side = 5.5%. The difference between data sources can shift the final Ke by 0.5–1.0%.

How do I use Build-Up Ke in a WACC calculation?

WACC = (E/V) × Ke + (D/V) × Kd × (1 − Tax Rate). Where E = equity value, D = debt value, V = E + D (total capital), Kd = cost of debt (interest rate on the company’s borrowings), and Ke = Build-Up cost of equity. Example: a private company with Ke = 19.5% (from our Build-Up above), Kd = 7.0%, tax rate = 25%, financed 70% equity and 30% debt: WACC = (0.70 × 19.5%) + (0.30 × 7.0% × 0.75) = 13.65% + 1.575% = 15.23%. Note: for private company DCF valuations under the income approach (IRS Rev. Rul. 59-60, ASC 805): the WACC is applied to unlevered free cash flows (FCFF) to produce Enterprise Value. Levered free cash flows (FCFE) are discounted at Ke directly.

What is a reasonable Company-Specific Risk Premium (CSRP) range?

CSRP typically ranges from 0% to 8%, with most business valuations falling between 1–5%. Guidelines by business type: (1) 0–1%: well-managed business with multiple key employees, diversified customer base, long-term contracts, strong systems and processes, established brand — limited idiosyncratic risk beyond what SP captures. (2) 2–3%: owner-dependent with some key employees, moderate customer concentration (one customer = 20–35% revenue), no long-term contracts but strong relationships. (3) 4–6%: single-owner-operated, one or two dominant customers, single-location, limited management depth, no formal systems. (4) 6–8%: highly owner-dependent (owner IS the business), single dominant customer (>50% revenue), pending litigation, sector in structural decline, or other severe idiosyncratic risk. Values above 8% are rarely defensible without exceptional circumstances and specific evidence.

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