How to Adjust Beta for Private Companies

Calculating beta for private companies is tricky but essential. Unlike public companies, private firms lack stock price data, making it impossible to directly measure beta. Instead, you estimate beta by analyzing similar public companies, adjusting for their capital structures, and accounting for private company-specific risks like size and liquidity.
Here’s the simplified process:
- Pick comparable public companies: Match by industry, size, geography, and business model.
- Unlever beta: Remove the impact of debt from the public companies' betas using the Hamada equation.
- Relever beta: Adjust for your private company’s debt-to-equity ratio.
- Account for private risks: Add adjustments for size, liquidity, or undiversified ownership.
- Plug into CAPM: Use the adjusted beta to calculate the cost of equity.
This method ensures a tailored risk estimate for private firms, improving valuation accuracy for funding, M&A, or IPOs.
What Beta Means for Financial Valuation
Beta is a key metric in financial valuation, representing systematic risk. It essentially shows how much a company's value fluctuates in comparison to the overall market. For example, if the S&P 500 rises by 10%, a company with a beta of 1.5 would generally see its value increase by 15%. On the other hand, a company with a beta of 0.8 would only experience an 8% rise.
Beta plays a pivotal role in the Capital Asset Pricing Model (CAPM), which is used to calculate the cost of equity capital. The formula looks like this:
Cost of Equity = Risk-Free Rate + Beta Ă— (Market Return - Risk-Free Rate)
Let’s break it down with an example. If the 10-year Treasury rate (serving as the risk-free rate) is 4.5%, the expected market return is 10.5%, and your company’s beta is 1.2, the cost of equity works out to 11.7%. In practical terms, this means equity investors would expect an annual return of 11.7% as compensation for the risk of investing in your company. This calculation becomes especially important when beta adjustments are made for private companies.
Private companies rely heavily on accurate beta estimates during critical moments like funding rounds, mergers and acquisitions (M&A), and IPO preparations. A high beta, such as 2.0, signals greater volatility, which increases the cost of equity and can lower valuations. For example, during M&A transactions, beta helps acquirers determine whether a target company’s risk profile fits their investment strategy and return goals. These decisions hinge on how well beta adjustments are incorporated into financial models.
The stakes are even higher during IPO preparations, where beta becomes a crucial tool for pricing shares and communicating risk to potential investors. Investment banks often use Bloomberg’s adjusted beta formula - Adjusted Beta = Regression Beta × 0.67 + 1.00 × 0.33 - to smooth out data fluctuations and provide more reliable risk estimates for valuation purposes.
Unlike public companies, private firms cannot calculate beta directly from stock price movements. Instead, they estimate beta by analyzing comparable public companies and then adjust for factors like leverage, company size, and liquidity. This process ensures the beta reflects the unique risk characteristics of the private entity. For instance, as companies grow and stabilize, their beta tends to drift closer to 1.0, making raw historical betas less reliable without proper adjustments.
For growth-stage companies, particularly those working with advisory firms like Phoenix Strategy Group, getting beta right is essential. An accurate beta not only bolsters financial models but also strengthens investor confidence during fundraising and exit strategies. For example, a private manufacturing company might initially use a public peer’s levered beta of 1.4. However, after unlevering and adjusting for its debt-free capital structure, the beta might drop to 1.0. With a market risk premium of 6%, this adjustment reduces the cost of equity from 12.9% to 10.5%. That seemingly small difference can have a major impact on valuation and investment decisions.
Understanding beta’s role in financial valuation lays the groundwork for the comparable company analysis and adjustment methods we’ll explore in the next sections.
Finding Comparable Public Companies
Adjusting beta for private companies starts with identifying the right public companies to use as benchmarks. The goal is to find public companies that closely match your private company's risk profile, which requires thoughtful selection and access to reliable financial data.
How to Choose the Right Comparable Companies
The first step in finding comparable companies is industry classification. Focus on companies that share the same primary Standard Industrial Classification (SIC) or North American Industry Classification System (NAICS) code. For example, a software company focused on healthcare solutions will have different risk factors than a general enterprise software provider, even if both are categorized under the broader technology sector.
Revenue size is another critical factor. A private company generating $50 million annually shouldn't rely on beta data from Fortune 500 companies with $10 billion in sales. Larger companies often have diversified revenue streams, established market dominance, and slower growth rates, which can skew beta calculations. Instead, look for public companies with revenue in a similar range - typically one to three times your company's size.
Geographic markets also play a significant role in risk assessment. A private company operating only in the U.S. faces different economic, regulatory, and currency risks than a multinational corporation. International operations can introduce additional risks, such as currency fluctuations and political instability, which can increase beta.
Business model similarities often outweigh broad industry comparisons. Factors like customer concentration, recurring versus transactional revenue, contract length, and capital intensity can significantly impact risk profiles. For instance, a subscription-based software company has more predictable cash flows than a project-based consulting firm, even if both operate in the tech sector.
Aim to identify five to ten public companies that meet these criteria. Fewer than five may not provide enough data diversity, while more than ten could dilute insights with companies that don’t closely align with your business. If finding direct comparables proves challenging, consider adjacent industries or companies slightly above or below your size range.
Getting Beta Data from Public Companies
Once you’ve selected comparable companies, the next step is gathering their beta values. Professional platforms like Bloomberg, Capital IQ, FactSet, and WRDS (Wharton Research Data Services) are the most reliable sources for beta data due to their advanced methodologies and extensive data coverage.
For detailed beta calculations, platforms like WRDS (using CRSP data) allow you to extract beta values over periods ranging from 24 to 60 months. The data can typically be exported to Excel for further analysis. While free sources like Yahoo Finance and Google Finance also provide beta values, they lack the rigorous methodologies of professional tools.
Pay close attention to the calculation methodology used by each platform. Some sources calculate beta based on daily stock returns over two years, while others use weekly or monthly returns over three to five years. The choice of benchmark index - such as the S&P 500, Russell 2000, or an industry-specific index - also impacts beta values.
Time period selection is particularly important during volatile markets. For instance, periods like the March 2020 COVID-19 crash or the 2008 financial crisis can inflate beta values, making them less reflective of normal conditions. To account for this, consider averaging beta values over multiple time periods to smooth out anomalies caused by market disruptions.
After gathering beta values, calculate a simple average or median to establish a baseline beta for your analysis. If a company’s beta appears unusually high or low, investigate further. Unique circumstances - such as pending lawsuits, recent acquisitions, or changes in capital structure - can distort beta and may justify excluding that company from your data set.
Finally, document your data sources and methodology thoroughly. Record the platform used for each beta value, the time frame for calculations, and any adjustments made. This documentation is especially important when presenting your valuation to stakeholders, such as investors or acquirers, who might scrutinize your assumptions. For companies working with advisory firms like Phoenix Strategy Group, detailed documentation adds credibility to financial models used in fundraising or M&A activities.
With these levered betas in hand, the next step is to unlever and then relever them to reflect your private company’s capital structure.
Unlevering and Relevering Beta
When working with beta values, it’s important to adjust them to align with your private company’s capital structure. Public companies often have different levels of debt, which directly impacts their risk profile. By unlevering and relevering beta, you can separate the underlying business risk from financial risk and then tailor it to your company’s debt-to-equity ratio.
Unlevering Beta: Stripping Out Debt Risk
Unlevering beta removes the financial risk tied to debt, leaving only the business risk that stems from a company’s operations. This step is crucial because public companies used for comparison often have varying capital structures, and normalizing these differences ensures a fair analysis.
The Hamada equation is the standard formula for unlevering beta:
βU = βL / [1 + (1 - Tax Rate) × (Debt/Equity)]
Where:
- βU = Unlevered beta (pure business risk)
- βL = Levered beta (total risk from public company)
- Tax Rate = Corporate tax rate (21% for U.S. companies as of 2025)
- Debt/Equity = Market value of debt divided by market value of equity
Let’s break it down with an example: A public software company has a levered beta of 1.4, a debt-to-equity ratio of 0.3, and a corporate tax rate of 21%. Using the formula:
βU = 1.4 / [1 + (1 - 0.21) × 0.3] = 1.4 / [1 + 0.237] = 1.4 / 1.237 = 1.13
This calculation reveals that the company’s business-only risk (unlevered beta of 1.13) is lower than its total risk (levered beta of 1.4). The difference - 0.27 - represents the extra risk added by debt financing.
To ensure accuracy, use market values for debt and equity. The market value of equity is calculated as the stock price multiplied by the number of shares outstanding, while the market value of debt can often be approximated using book values if market data isn’t available. Many financial platforms provide these ratios, but double-checking your inputs is always a good practice.
Apply this process to each company in your comparable set. For example, if you’re analyzing seven companies, calculate the unlevered beta for each and use the median value rather than the average. The median helps minimize the influence of outliers, giving you a more reliable result.
Once you’ve determined the median unlevered beta, you’re ready to adjust it for your private company’s capital structure.
Relevering Beta: Tailoring to Your Company
After determining the unlevered beta, the next step is relevering it to reflect the specific debt-to-equity ratio of your private company. This involves applying the Hamada equation in reverse:
βL = βU × [1 + (1 - Tax Rate) × (Debt/Equity)]
Here’s an example: Suppose your private company has $2 million in debt and $8 million in equity, giving it a debt-to-equity ratio of 0.25. If the median unlevered beta from your comparable companies is 1.13, the relevered beta would be:
βL = 1.13 × [1 + (1 - 0.21) × 0.25] = 1.13 × [1 + 0.1975] = 1.13 × 1.1975 = 1.35
This new beta of 1.35 reflects both the business risk of comparable companies and the financial risk tied to your company’s specific capital structure.
Timing matters when calculating your debt-to-equity ratio. For instance, if you’re valuing your company for fundraising, consider whether the new capital will come from debt or equity and how that will shift your structure. In M&A scenarios, buyers may use their own capital structure, which could differ significantly from yours.
For companies with low debt - like many software firms - the debt-to-equity ratio may be close to zero. In such cases, the relevered beta will be nearly identical to the unlevered beta because financial leverage is minimal. On the other hand, industries like manufacturing or real estate, which often rely heavily on debt, will see a much higher relevered beta due to the added financial risk.
Keep a record of all assumptions and calculations. This documentation is especially valuable when working with advisory firms like Phoenix Strategy Group during fundraising or M&A deals. Potential investors or acquirers will want to scrutinize your methodology, and clear records help justify your beta assumptions.
The relevered beta you calculate plays a critical role in determining your cost of equity. However, you may need to adjust further to account for the specific risks associated with private companies.
Adjusting Beta for Private Company Risks
While relevered beta accounts for your company's capital structure risks, private companies face additional challenges. Factors like smaller size, limited liquidity, and concentrated ownership introduce unique risks that require careful adjustments to reflect the true risk profile.
Adding Size and Liquidity Adjustments
Private companies often experience higher risks due to their size and the lack of liquidity in their shares. These businesses tend to face greater volatility, restricted access to capital, and more frequent disruptions. Additionally, the absence of a public market for their shares introduces illiquidity risk, which investors typically expect to be compensated for.
One way to address this is by incorporating a size premium into the cost of equity calculation, rather than modifying beta directly. However, some analysts prefer to adjust beta itself. For example, applying a 20% adjustment to a beta of 1.35 would increase it to 1.62. The size of the adjustment depends on factors like the company's size, industry characteristics, and management quality. Smaller firms or those with less diversified customer bases might need a larger adjustment, while larger or more stable companies may require only minor modifications.
To deepen the risk assessment, you can also factor in undiversified risk using total beta.
Using Total Beta for Undiversified Risk
Private companies often face undiversified risks that go beyond size and liquidity concerns. Traditional beta measures only systematic risk, under the assumption that investors hold diversified portfolios to offset company-specific risks. However, private company owners often have concentrated positions, leaving them exposed to both systematic and unsystematic risks.
This is where total beta comes into play. Total beta accounts for the full risk profile by looking at overall volatility relative to the market, regardless of correlation. It can be calculated as:
Total Beta = Standard Beta / Correlation Coefficient
For instance, if a standard beta is 1.2 and the correlation with the market is 0.6, the total beta would be 2.0.
This measure is particularly valuable in scenarios like mergers and acquisitions or management buyouts, where undiversified exposure is a key consideration. Total beta adjustments can vary greatly depending on the industry. Mature companies with strong market correlations might require only small adjustments, while niche firms could need significantly larger ones.
When working with Phoenix Strategy Group on valuation projects, it’s critical to evaluate whether total beta is the most suitable measure for your specific situation. For example, if you’re preparing for a sale to a public company with diversified holdings, standard beta might suffice. But if the buyers include private equity firms or strategic acquirers with concentrated investments, using total beta could offer a more accurate risk assessment.
Choosing the right beta methodology is essential, as it can significantly influence the calculated cost of equity and overall valuation. Tailor your approach to the specific transaction and the profile of potential investors to ensure an accurate reflection of risk.
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Using Adjusted Beta in Financial Models
Once you've fine-tuned your beta adjustments, the next step is incorporating these figures into your financial model to calculate the cost of equity. It's essential to clearly document all assumptions during this process. This step connects your beta calculations with the broader framework for determining the cost of equity.
Plugging Adjusted Beta into CAPM
Start by using the current 10-year U.S. Treasury yield as your risk-free rate. For the market risk premium, many professionals rely on a range between 5.0% and 7.0%, depending on specific market conditions and the analysis at hand.
Here’s an example to illustrate: Suppose you’re working with a private manufacturing company that has an adjusted beta of 1.45. If the risk-free rate is 4.2% and the market risk premium is 6.0%, the calculation would look like this:
4.2% + (1.45 Ă— 6.0%) = 12.9%
If you determine that using total beta is more appropriate and calculate it at 2.1, the result changes:
4.2% + (2.1 Ă— 6.0%) = 16.8%
To maintain clarity and enable sensitivity analysis, keep each component of the Capital Asset Pricing Model (CAPM) in separate cells within your financial model.
Recording Your Financial Model Assumptions
Once you've calculated the cost of equity, take the time to document every assumption. A dedicated assumptions page can help validate your model and provide a clear overview of key decisions. Include the following details:
- Comparable companies selected and their individual betas.
- Data sources and retrieval dates.
- Debt-to-equity ratios and tax rates used in calculations.
If you’ve made additional adjustments, such as applying a size premium, explain the factors influencing this decision - like revenue, employee count, or market position compared to peers. For total beta calculations, note any extra considerations that shaped your approach.
Add a short narrative outlining your beta adjustment process. For example, Phoenix Strategy Group recommends thorough documentation when preparing companies for due diligence. This level of detail demonstrates analytical precision and strengthens confidence in your valuation conclusions.
Whenever possible, link assumptions to external data sources rather than hard-coding figures. Cite references for market risk premiums - whether they come from academic studies, industry surveys, or investment banking benchmarks. This approach makes it easier to update your model as market conditions shift.
Finally, incorporate sensitivity analysis around key beta assumptions. This will help illustrate how changes in these inputs can impact the valuation, giving stakeholders a clearer picture of potential outcomes and the range of possibilities.
Key Steps for Adjusting Beta
Adjusting beta for private companies involves a structured process that adapts public market data into risk metrics specifically suited to your business. Here's how to approach it effectively:
1. Choose comparable companies wisely. Begin by selecting 3–5 stable companies that closely resemble your business. The accuracy of your beta calculation hinges on the quality of these comparables.
2. Unlever the beta to focus on business risk. Strip away the effects of each comparable company's capital structure by factoring in their debt-to-equity ratios and tax rates. This step isolates the operational risk tied to their business models, free from financing decisions.
3. Relever beta to reflect your company's structure. Use your private company's target debt-to-equity ratio and tax rate to adjust the unlevered beta. This step incorporates the financial risk unique to your company's financing choices.
With these adjustments, you now have a beta tailored to reflect your business's specific risk profile. But there’s more to consider.
4. Account for private company-specific factors. Add a size premium, typically between 1–5%, based on your company's revenue and market cap. Don’t forget to adjust for liquidity, especially if your shares are not easily tradable. If your company has concentrated ownership or limited diversification opportunities, it might make sense to evaluate whether total beta provides a more accurate measure of risk.
5. Test the sensitivity of your beta adjustments. Small tweaks to beta can lead to noticeable changes in valuation. Understanding how these adjustments impact your models helps you communicate potential risk ranges clearly to stakeholders.
The adjusted beta plays a key role in determining the cost of equity within the Capital Asset Pricing Model (CAPM). When done correctly, this process transforms general market data into a risk metric that aligns with your industry's dynamics and your company's unique characteristics. This, in turn, strengthens the accuracy of your financial models and supports better decisions around capital allocation, funding, and growth strategies.
For companies gearing up for fundraising or a potential sale, presenting well-documented beta adjustments signals to investors and acquirers that your financial analysis is thorough and reliable - an essential factor during due diligence.
FAQs
How can I select the best comparable public companies to adjust beta for a private company?
To estimate beta for a private company, the first step is to find public companies operating in the same industry or sub-industry. These companies should share similar business models and operate under comparable market conditions. Pay attention to factors like size, financial performance, and geographic reach, as these play a crucial role in determining beta values.
By selecting firms with aligned risk profiles and operational traits, you can achieve a more precise beta calculation. This method lays the groundwork for making sound financial decisions that align with the private company's specific circumstances.
What is the difference between standard beta and total beta, and how do I decide which to use for valuing a private company?
Standard beta measures a company's systematic risk relative to the overall market. It's most often applied to public companies where market data is readily available. On the other hand, total beta takes a broader view of risk by factoring in both equity and debt, reflecting the company's specific capital structure and leverage.
For private company valuations, standard beta is usually derived from comparable public companies. Total beta, however, becomes crucial when adjusting for the private company's unique leverage and risk characteristics. This approach, particularly during unlevering and relevering, helps provide a clearer picture of the company's actual financial risk.
Why is it necessary to adjust beta for private companies, and how do factors like size and liquidity affect the cost of equity?
Adjusting Beta for Private Companies
When it comes to private companies, tweaking the beta is crucial because factors like size and liquidity play a major role in shaping their risk profile. Smaller firms and those with limited liquidity are typically seen as riskier compared to their larger, publicly traded counterparts. If these additional risks aren't factored in, there's a good chance the company's cost of equity will be underestimated.
By recalibrating beta to account for these unique risks, you get a clearer picture of the company's actual risk level. This adjustment often results in a higher beta, which in turn leads to a higher cost of equity. Why does this matter? It helps ensure valuations are grounded in reality, giving investors and advisors the tools they need to make smarter financial decisions. For private companies aiming to grow or secure funding - like those supported by Phoenix Strategy Group - this step is a critical part of crafting a solid financial strategy.