Breaking Down the Assumptions Behind ESG Valuation Modeling

Valuation professionals are increasingly being asked to quantify the impact of ESG on privately-held businesses. While the goal is clear, the challenge lies in the assumptions—because every model is only as strong as the inputs behind it.

So what assumptions actually go into an ESG-adjusted discounted cash flow (DCF) model? Let’s walk through the logic that underpins these projections.

1. ESG Affects Revenue Growth

In a positive implementation scenario, it’s assumed that strong ESG performance can create pricing power, brand loyalty, and access to new markets. In our models, a 10.5% increase in revenue (triple the long-term sustainable growth rate) was used to simulate this impact.

In contrast, a neutral or negative scenario keeps revenue growth flat or modest—around 3.5%, which aligns with average industry expectations.

2. ESG Drives Expense Increases

Implementing ESG comes with real costs. Key areas include:

• Salaries & Wages (+10%)

• Benefits (+10%)

• Cost of Goods Sold (+15%) due to ethically sourced inputs

• Advertising & Admin (+8%) to promote ESG efforts and handle compliance

• Rent (+8%) due to facility upgrades or ESG-driven lease terms

These increases reflect industry research and best-practice estimates, and they compound significantly across the forecast period.

3. ESG Influences Risk and Discount Rates

Risk is modeled using the Build-Up Method, and ESG primarily affects the Company-Specific Risk Premium (CSRP). In a successful scenario, the CSRP is reduced by 0.50%, lowering the cost of equity and WACC. In an unsuccessful implementation, it increases by 0.50%.

This shift in perceived risk materially alters the discount rate and the resulting present value of cash flows—sometimes by millions of dollars.

Why These Assumptions Matter

They don’t just change valuation outcomes—they shape strategic decisions. If business owners believe ESG can improve brand value and reduce risk, they may accept the upfront costs. If not, they may delay or reject ESG integration entirely.

As valuation professionals, our job is not to guess—but to build scenarios rooted in logic and supported by data. ESG is no exception.