Beta, which is a measure of systematic risk is used for expressing the volatility of a security compared to benchmark. The beta gives answer to the question of “How the company’s equity market value changes compared to changes in overall market?”
Determining beta requires regression analysis of the stock return against market. This is not a big deal since we can implement such regression analysis by using historical stock-return information, but what will we do if we don’t have historical market data, which is mostly the case in private companies, illiquid and not listed stocks?
We can list the steps to find the beta without historical data as follows
1. Find the publicly-traded companies which are operating similarly to the private company
2. Find the average beta of these publicly-traded companies and note that this is your industry average levered beta.
3. Now you have to unlever this approximate industry average beta. So unlever it by using average D/E (debt-to-equity) ratio.
4. Now you have unlevered beta, which means now its time to re-lever beta, but this time by using target private company’s D/E ratio, not the average
1&2 -Assume we are looking for the beta of private company named A, and after some investigation we found comparable companies and get such table
Companies Beta Debt Equity D/E Ratio
Company B 1.5 5,658 25,008 0,23
Company C 1.57 10,470 65,780 0,16
Company D 1.63 75,340 135,348 0,56
Weighted Average Beta
(0.33x1.5 + 0,33x1.57+0,33x1.63) =1,56
Weighted Average D/E
(0,33x0,23+0,33x0,16+0,33x0,56) = 0,426
Note! I simply take the weights equal but normally the size etc. of the comparable companies requires different weights.
3- Let’s Unlever the average beta
Unlevered Beta= Levered Beta / 1+(1- Tax Rate)* Average D/E
Assume that Tax Rate is given as 0,32
=1,56/ 1+(1-0,32)*0,426 = 1,21
Now say the private company A has target D/E ratio of 0,4
4- Lever by using target D/E ratio
Levered Beta = Unlevered Beta *[1+(1-Tax Rate)*Target D/E)
= 1,21 *[1+(1-0,32)*0,3]= 1,45 which is the beta of illustrative private company
Note! In this example the beta of the private company is lower than average levered beta due to lower D/E ratio
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