The meaning of a “discount rate” is best understood by making a parallel with the interest rate you get from the bank on your savings account. While the interest rate is a % you use to calculate what 100 USD or EUR on your account will become after a number of years, the discount rate is a % to convert future cash into today’s money.

A start-up company with a product in development, for instance, will (hopefully) generate revenues in the future. The revenues in years x, x+1, x+2 etc. need to converted into today’s value with a discount rate. By first deducting future expenses from all future annual revenues, you get the *Free Cash Flow* in each year and when discounted those future free cash flows back to today, you will get what is called the company’s *Discounted Cash Flow*.

The discount rate will thus have a huge impact on the calculation of the value of a company. It is a % that will need to be determined in the valuation process, and it is not just the interest rate you get on a bank, but needs to also incorporate several risk factors. There are two kinds of risk factors that will need to be taken into consideration in the case of a biotech company with no products on the market:

- The general risk associated with the characteristics of the company, of which its management definitely the most important one.
- The product specific risk: obviously, a development project in phase 1 is much riskier than a phase 3 project. (this risk can be applied separately for a risk adjusted net present value calculation rNPV)

In other words, these are risk factors that determine whether the investor will ever see his/her money back, and collectively they will drive up the discount rate to a much higher % than the interest rate you get from the bank.

If you are interested to learn more about how to value companies and biotechnology products, our one day valuation workshop is a must. See more here ››