Equity is Expensive: Understanding Businesses’ True Cost of Capital

By: Ksusha McCormick, Chief Executive Officer, OneAM
Published Thursday, May 8, 2025 | Estimated read time: 3 min

If you’re a small or medium business (SMB) owner, you know all too well that the success of your business comes down to securing the capital needed for survival and growth.  While the cost of debt is typically clearly advertised by lenders – an annualized interest rate plus fees, the cost of equity capital is much more opaque.  To be sure, debt and equity have their pros and cons, but at the end of the day, funding is funding.  Therefore, it’s important for owners of small businesses, regardless of whether they’re self-funded or seeking venture or private equity capital, to understand the cost of equity and compare it on an apples-to-apples basis with debt.

Breaking Down the Cost of Equity 

For SMBs, accurately assessing the cost of equity can feel challenging, but there are plenty of commonly used tools - one being the Capital Asset Pricing Model (CAPM). The CAPM formula is: 

Cost of Equity (CoE) = [ Rf + β * Rpremium ] + “Small Business Premium” 

• Rf  (Risk-Free Rate): Typically, the yield on the 10-year Treasury—currently hovering around 4.3%. 

• Rpremium (Market Premium): The return on stocks above the risk-free return. A well-respected provider of valuation data (Kroll) currently estimates the market premium to be 5.5%.  An alternative calculation method is subtracting the risk-free rate from the expected total return on the stock market. Historically, the stock market returns roughly 9-10% annually – leading to an estimate of 4.7% to 5.7%, very similar to Kroll’s. 

• β (Beta): A measure of volatility or risk compared to the overall market. For SMBs, this is often significantly higher than the market average of 1.0, frequently ranging from 1.5 to 3.0 or even higher due to increased risk and volatility. NYU Stern maintains a well-respected database of valuation metrics and estimates the beta for SMBs (market cap between $20 - $175 million) to be 3.5. 

Plugging these numbers in: 

Cost of Equity (CoE) = [ 4.3% + 3.5 * 5.5% ] + “Small Business Premium” = 23.55% + “Small Business Premium” 

This theoretical baseline of 23.55% already looks steep! And that’s before adding the “Small Business Premium”.

Small Business Premium 

For smaller, and especially private, businesses, investors require additional returns - a premium - to compensate for liquidity risks, lack of transparency, limited financial controls, and less predictable revenues. Typically, studies report small-business premiums ranging between 5% to 10% above public market rates. However, these numbers often underestimate the real-world scenarios experienced by SMBs, where the premium can be significantly higher—closer to 15% or more in practice. 
 
That adds up to a current cost of equity for small private businesses in the neighborhood of 28% - 39%!  This may feel like a theoretical result, but it tracks surprisingly well with the real-life target returns of venture capital and private equity firms.  When converted to IRR terms, the gross returns these types of investors try to obtain are in the 25-30% range.

The Bottom Line 

In addition to its high cost, equity capital comes with other well-known downsides – dilution, too many cooks in the kitchen, and potential loss of control by the business founders.  What’s a business owner to do?  One option is to consider early pay.  Early pay is neither debt nor equity – it’s simply a way to boost your cash position and help your business move in the right direction faster.  At OneAM, we’re passionate about providing it in the fastest, easiest way possible, at fair and affordable terms.

OneAM Early Pay 

OneAM offers a flexible, business-friendly financing alternative for businesses delivering B2B products and services to large customers. Our receivables finance solution is neither debt - which adds a liability to your balance sheet - nor equity, which is expensive and dilutive. OneAM’s value in a nutshell: 

• No dilution of ownership: Retain full control of your business without giving away equity or decision-making power 

• Predictability and simplicity: Know exactly how much you’re paying and when 

• Flexibility: Accelerate cash flows precisely when you need them, mitigating operational risks 

• Ease and Speed of Onboarding: Takes minutes and doesn’t add a lot of overhead to your business processes

Learn more on our website and schedule a demo at info@oneam.us.