Most Institutional equity investors don’t rely on NPV/DCF type valuations because its apparently rigorous approach hides some very shaky foundations – uncertainty of forecasts and often high variability as the discount rate is changed. Those that do typically use 8-10% almost without exception (that’s my 13 year experience as an analyst at Merrill). But this is for track-record companies with liquid share trading. Some use CAPM to justify, others just say “that’s my required return and I won’t invest if it doesn’t meet that hurdle”.

But don’t waste time doing NPV type valuations in your start-up business plan. I’ve not met a VC who uses NPV/DCF etc to value start-up businesses because the model doesn’t work well in high uncertainty situations. In fact they are usually rather rude about carefully prepared DCF models. I’ve only seen this approach in leveraged private equity situations for mature businesses. Is this you?

VC’s have much higher individual company return requirements because their failure rate is much higher than institutional investors. A 10x multiple on initial investment in 5 years is 59% required return…! If your NPV survives a 59% discount rate, then VC’s should be interested!

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1. Mergers & Acquisitions: A high failure rate