Glossary 6: Beta and the use of beta in Private Equity
Beta is a financial metric that measures the sensitivity of an asset’s returns in relation to the overall market movements, typically represented by a stock market index.
In the realm of private equity, Beta plays a crucial role in valuing a private company, particularly when its shares are not publicly traded. In the absence of market-traded stock prices, private equity professionals employ a methodological approach to derive a proxy Beta for private company. Initially, Beta values of comparable publicly listed companies are utilized. The process involves de-leveraging the Betas of these comparables to remove the impact of their existing debt structure, resulting in unlevered Betas. Subsequently, the unlevered Beta is re-leveraged by applying the target Debt-Equity ratio specific to the private company. This final re-levered Beta serves as a crucial proxy in the valuation process of a private firm.
By meticulously de-leveraging and re-leveraging Betas, private equity professionals can enhance the accuracy of their estimation on Beta of the private firm and thus its valuations, in the absence of direct market-traded data.
