Beta or Total Beta? The Answer Depends on the "Company" It Keeps

Determining an appropriate cost of capital for a privately-held company is a very difficult undertaking. There are no specific private company benchmarks. Therefore, appraisers turn to rates of return and data from the public stock markets. According to traditional financial theory, portfolio managers interested in well-diversified portfolio construction should use traditional betas as a measure of systematic risk when adding stocks to a portfolio. Traditional betas, on the other hand, do not mean all that much for the valuation of privately-held companies. Business owners who have placed a large majority of their net worth in one asset, unlike well-diversified portfolio owners, cannot shed company-specific risk (CSR). Unlike for publicly-traded stocks, therefore, CSR is often priced for privately-held companies. A relatively "new" beta known as total beta captures total risk, including by definition CSR. Therefore, appraisers should use total beta benchmarks from publicly-traded guidelines to better support their selection of an appropriate discount rate to value a privately-held company. Peter Butler has written and spoken extensively in the United States on this topic and has developed an online application for appraisers known as the Total Cost of Equity Calculator to calculate guidelines' total betas and resulting discount rates available at www.bvmarketdata.com.