Volatility of interest rate

Hello guys,

I'm part of team that is responsible for the valuation of a portfolio of venture debts (early stage, pre-revenue companies,...) denominated in EUR.

The value of the venture debt is typically estimated based on a DCF model. In order to capture the change in market conditions in the discount rate, we have selected the Z-spread corporate yield curve (B-rated - EUR denominated) from S&P as the benchmark (which is far from being the best benchmark but we do not have access the better data for now).

However, this benchmark is typically around 200bps to 800bps and the IRR of the venture debts at signature date ranges from 1000bps to 2500bps. I'm talking about IRR because we calibrate the discount rate in the DCF model to the cost of the operation at signature date in order to determine the discount rate that provides a fair value equal to the cost (this is required by accounting standard considering the non observable parameters for this type of private instrument).

For now, the model assumes a very simplified (but unrealistic) approach: if the discount rate on the benchmark (i.e. the B-curve for EUR bonds) increase / decrease by 1%, the discount rate increase/decrease by X1% where X is computed as the ratio of the IRR of the venture debt at signature date and the level of the benchmark at signature date. Ex. If the IRR is estimated as 15% and the benchmark at signature date is 5%, then the "X" is 3 and any increase of 1% in the benchmark will be translated by an increase of 3% in the discount rate considered in the discounted cash flows. The idea off course is that the volatility is expected to increase with the level of interest rate.

However, this creates a lot of volatility in the portfolio because the sensitivity of the portfolio of venture debt to the benchmark is huge (and in my view overestimated with this simplified approach).

Therefore, I'm looking for some idea / model that can help me to support a smoother sensitivity of the portfolio of venture to debt to this benchmark.

Thanks in advance for your help