Specific Company Risk – Russ Glazer
The income approach is applied in virtually all valuations of closely held businesses. This requires several inputs, including an estimate of future cash flows and the determination of an appropriate rate of return (discount rate). An important element of the discount rate is historical data on the annual returns from the public stock markets over a long period of time. But the public market returns cannot fully capture the unique characteristics of the subject company, so the analysis must exercise informed judgement and add a “company specific’ risk component” to the analysis.
The company specific risk is intended to allow for those elements of the subject company’s risk (due to size, depth of management, geographic diversity, etc) that are not captured in the public market returns.
There are no published empirical studies that measure the appropriate amounts of the specific company risk; this must be developed by the analyst. However the business valuation literature offers some guidance.