A great benefit of living in today’s technological age is the opportunity to go “back to school” to take in recent lectures of prominent college professors. In the field of valuation, there is likely no more highly regarded college professor than Dr. Aswath Damodaran of New York University, whose entire Spring MBA 2025 valuation course is publicly available online.
Session 21 of Damodaran’s Spring MBA 2025 valuation class, recorded on April 16, 2025, provides instruction on the valuation of private (versus public) companies and includes several insightful observations regarding such valuations.[1] However, interested parties might find session 21 remarkable for not only what it includes but also what it excludes.
Exclusion of the (Ubiquitous) Size Premium
Notably absent from session 21 is the oft-cited and so-quantified adjustment of the size premium (“SP”),[2] which, according to popular wisdom, ought to be employed when figuring cost of equity (“COE”) estimates in virtually all private company valuations. This apparent omission, while on one hand glaring given the widespread acceptance and usage of SP by most valuation practitioners, is on the other hand understandable given both SP’s documented weaknesses[3] and Damodaran’s attendant track record of being extremely critical of it.[4] This dissonance, while certainly not the sole example of disagreement in valuation opinion and practice, is perhaps one of the more striking examples of it.
Inclusion of a Risk Element for (Suboptimal) Diversification
Just a few minutes into session 21, Damodaran lays the foundation for a lone, additional risk element when estimating COE for a “smaller” private, versus a “larger” public, company that has nothing to do with SP but, rather, everything to do with the relative level of diversification realized by the marginal investor in either company: “It’s not really a question of private versus public. It’s who the investor in the business is and whether they’re diversified. . . .”[5]
Damodaran goes on to suggest that when valuing a private company, analysts should not be including SP, nor any other such questionable risk factor, in their COE models but rather should be considering an additional risk element for the relatively poorer diversification that is likely to be realized, in some measure, by the marginal investor in that private company (versus the reduced risk from greater diversification that is readily available for the marginal investor in publicly traded stocks). This contrast between investments that carry material diversification risk and those that readily offer material diversification benefits is well-taken, given that traditional risk-and-return models incorporate as their foundation the pricing and characteristics of publicly traded stock. Indeed, as Damodaran notes on slide 136 of this Spring 2025 presentation, “[c]onventional risk and return models in finance are built on the presumption that the marginal investors in the company are diversified.”[6]
The Practical Boundaries of Diversification-Related Risk (and Return)
Damodaran’s example in session 21 of valuing a mature, yet small, single-location French restaurant (beginning around 20:00 of the lecture, or slide 134) is both entertaining and helpful in illustrating how this single incremental risk element can, as a practical matter, describe the boundaries of diversification-related risk and return. Simply put, if a private individual invests effectively all his or her wealth in the restaurant, then that market participant might assess a COE more consistent with that derived using the concept of Total Beta (i.e., the highest effective COE, suggesting the lowest potential valuation, all else equal). Conversely, if a public company considers purchasing the restaurant, then that market participant might assess a COE that is more consistent with that derived using the concept of Beta (i.e., the lowest effective COE, suggesting the highest potential valuation, all else equal). While not necessarily prescribing a method by which to figure a COE between these two bookend notions of compensable risk during his lecture, Damodaran does acknowledge the existence and importance of this middle ground, as well as market participants who may fall therein, by commenting that “everyone else is going to fall somewhere in that continuum. . . .”[7]
Stuck in the Middle
Whether market participants for private companies end up at a particular point within this continuum through negotiation, or a more detailed analysis of compensable risk, or some other reason is largely beside the main point, which is that the boundaries of this continuum may be understood to be a function of a single additional risk element related to relative diversification. Accordingly, acknowledgment of the continuum itself, and how market participants for private companies may be “stuck” somewhere in the middle of it, appears to be as fundamental to understanding private company valuations as is the exclusion of specious risk/return elements from them.
In fact, given the decades-long proliferation of college textbooks that have encouraged generations of analysts to exclude questionable, or “fudge,” risk factors from their COE calculations, one might reasonably expect that the landscape of today’s valuation texts would reflect an ever-deepening root of that basic mandate. However, as Damodaran apprises his class later in session 21: “I know there are books on how to build a cost of capital from scratch for a private business. And most of them break every rule.”[8]
Synthesis
Going “back to school” can be illuminating on certain key aspects of private company valuations. One of these key aspects relates to suboptimal diversification and, specifically, how the marginal private company investor may bear incremental risk from it relative to the marginal public company investor. Accordingly, valuation analyses of private companies that communicate and quantify such a “diversification discount,” while simultaneously eschewing specious risk/return elements, may intimate that their preparers have been “back to school.”[9]
Aswath Damodaran, Session Webcast No. 21: Recorded Session, Valuation MBA Spring 2025 (last visited Feb. 21, 2026) [hereinafter Session No. 21 Recorded Session]. Click link titled “Recorded Session” to begin the class recording. Note that Damodaran is currently on sabbatical as of the publication of this article in Spring 2026. ↑
SP may also be characterized in literature and valuation reports as the size effect, small-stock premium, or small-cap premium, among other similar terms. ↑
Numerous empirical studies conclude that SP is a market anomaly that lacks persistence in out-of-sample testing. In other words, these studies find SP to be a methodological artifact that weakens or disappears once examined outside of the original historical sample. See, for example, Ron Alquist, Ronen Israel & Tobias Moskowitz, Fact, Fiction, and the Size Effect, J. Portfolio Mgmt., Fall 2018. ↑
Note, for example, Size Effect Is “Fiction,” Damodaran Reiterates, BVWire (June 30, 2021). ↑
Session No. 21 Recorded Session, supra note 1, at 7:05. ↑
Id. at 22:40. ↑
Id. at 33:30. ↑
Id. at 35:50. ↑
See also Aswath Damodaran, Diversification, Control & Liquidity: The Discount Trifecta (last visited Feb. 21, 2026). ↑
