The Capital Asset Pricing Model (CAPM) is widely used in public markets to estimate expected returns. It is based on a simple idea:
The greater the risk, the greater the return should be.
The equation is:
Expected Return = Risk-Free Rate + Beta × (Market Return – Risk-Free Rate)
But startups don’t have listed prices, historical volatility, or measurable betas. So, how can CAPM help us think about startup risk?
Adapting CAPM for Early-Stage Investing
- Risk-Free Rate → Opportunity Cost
The return an investor could earn in safer, liquid alternatives. Startups must offer returns that meaningfully exceed this threshold. - Beta → Sensitivity to External Forces
In public markets, beta measures how much an asset moves with the broader market. For startups, beta is about how much the business depends on external factors such as fundraising, consumer trends, or platform changes. More external dependence means a higher beta. - Market Premium → Compensation for Uncertainty
Early-stage investing is full of unknowns such as product development, team execution, long holding periods, and limited liquidity. Investors seek a premium to account for this uncertainty, not as a penalty, but as recognition of what can’t yet be predicted.
While we cannot directly apply CAPM to calculate startup returns, it remains a valuable mental model for assessing risk with greater awareness, particularly in environments where outcomes are highly unpredictable.
Drawing on my background in finance and an academic perspective, I find that reflecting on models like CAPM is not about reducing startups to simple formulas, but rather about bringing greater clarity to the uncertainties inherent in early-stage ventures.
June 2025