Total Beta is the best and most complete measurement of risk for business appraisers to focus on in valuing privately held companies. Why? According to Keith Pinkerton, and Peter J. Butler, Total Beta:
- Has the same perspective that we use to value private companies–namely as a stand-alone asset. All other measures of beta represent systematic risk as part of a well-diversified portfolio that is most appropriate if you are a money manager or stock analyst–not a business appraiser.
- Captures 100% of historical (disclosed) risks. Such is the case, whether they are systematic or unsystematic risks, if the stock trades in an efficient market. No other measurement of beta, including Sum Beta, comes remotely close to this percentage.
- Is generally much more stable than any other beta measurement, providing more confidence in the measure of risk to compare and contrast risk factors between guidelines and your closely held company.
- Allows for direct comparison to public companies rather than relying upon averages of publicly traded data. For example: industry risk premiums used in the build-up approach capture all of the companies in an industry. Some of these companies may have little comparability to your private company. Gary Trugman’s book, Understanding Business Valuation: A Practical Guide to Valuing Small and Medium Sized Businesses, provides analyses of the Butler Pinkerton Model™: “Now, instead of using the entire industry, we can choose better guideline data as a starting point.”
- Captures all of the disclosed risks; one does not need to subjectively “correct” for any perceived low measurement of systematic risk—unless possibly the stock traded in an inefficient market.
- Provides a means to defend and support one metric—Total Beta—rather than Market Beta, the size premium, and the CSRP to a judge, jury, or client. Moreover, all three of these inputs are generally more subjective (read: more volatile) than Total Beta.
What do you think? You can access a free download, “There is a ‘New’ Beta in Town—and It’s Not Called Total Beta for Nothing!” from the March 2009 BVU, at BVResources. Read Pinkerton and Butler’s article and share your views.
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