Understanding the Firm Specific Risk Premium

Abstract We seek to determine whether a firm specific risk premium (FSRP) exists for private firms. We show that private equity investors price firm specific risk as part of establishing the expected rate of return hurdle rate. Our research is based on survey data constructed by the Private Capital Markets Project. We decompose the rate of return into its component parts-market risk premium, size premium, liquidity premium and firm specific risk premium (FSRP). We find that on average PE FSRP varies between zero and six percent. These findings indicate that the cost of capital buildup used in valuing private firms should include a premium for firm specific risk unless facts and circumstances suggest otherwise.