I agree that the typical vc investment will have convertible debt, if any debt exists at all. The warrants will need to be valued and included in the calculation of the effective interest rate of the debt.
To use a “market rate” of debt is not proper. That dilutes the WACC. If no convertible debt involved, then stick with the equity rate.
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From: Beaton, Neil via Listserv <listserv@ercllc.net>
Sent: Thursday, October 1, 2026 11:51 AM
To: John Schumacher <JCS@tfpov.com>; ERC Serve <listserv@ercllc.net>
Subject: [Listserv] Re: Plausibility of WACC - VC COE Yet Big Debt Component
Just my two cents: male cow manure. Most early-stage companies do not qualify for external debt funding and when they do, it is usually supplemented by a large swath of warrants (and those companies are usually later-stage start-ups).
The forecast should be based on equity cash flows and then discounted at 55%, but even then, the practice aid cautions against relying solely on a DCF for a company that has never turned a profit. Is the debt convertible? That could alter the assessment
as well. Happy to share more as needed.
Neil J. Beaton
Managing Director
Alvarez & Marsal Valuation Services
Cell: 206-963-5401
Direct: 206-664-8934 – Seattle
Direct: 415-490-2259 – Bay Area
Email:
nbeaton@alvarezandmarsal.com
From: John Schumacher via Listserv <listserv@ercllc.net>
Sent: Thursday, October 1, 2026 5:44 PM
To: ERC Serve <listserv@ercllc.net>
Subject: [Listserv] Plausibility of WACC - VC COE Yet Big Debt Component
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[EXTERNAL EMAIL]: Use Caution
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ERCers.
Have any of you ever prepared a traditional WACC analysis, applied in a 5-year DCF, where the required return on equity component was based on early stage VC rate of return as per the AICPA cheap stock practice aid (~55%), and then still
included a meaningful debt component in the WACC? Or alternatively, could this make sense to you in certain fact patters?
The certain fact pattern in the instant case is that the subject company does indeed have a significant amount of “interest-bearing debt” but the lender is also the majority shareholder, and thus the debt is not arm’s length. And the value
of the debt is almost certainly below its face value. The subject interest is a controlling interest (arguably so), in a privately held company that has never turned a profit and generated significant losses since its inception over 5 years ago. The forecast
at first blush is quite aggressive, so the VC rate of return for the equity makes sense to me, but the debt component of the WACC is completely neutering the equity rate of return as the opposing expert is assuming a capital structure in the WACC that is overwhelmingly
debt. The opposing expert is saying the % of debt in the capital structure was determined “iteratively” but does not specify the goal post for what he/she was iterating towards but I suspect it is anchoring on the cap structure of an outlier GPC that is well
below investment grade.
Any insight on something I have never seen in my 20+ years in valuation would be appreciated.
John
John Schumacher, CFA
Email:
jcs@tfpov.com |
Direct: 312.933.2148
True Financial POV,
LLC