What is Systematic Risk? And why it's Essential to Business Valuation

Many entrepreneurs and business owners think that risk means loss. But in fact, risk means volatility. If, for example, the value of a company can rise or fall, it means that the value of the company is something that changes and is therefore dangerous.
In finance, it is customary to divide the risk factors into two main groups - according to their risk characteristics - systematic risk and unsystematic risk. In this article, we will focus on systematic risk.
Systematic risk is the risk to which the firm is exposed due to risk factors exogenous to the firm. These risk factors can be economic, political, social, and more.
For example - inflation that causes prices to rise in the economy is not under the company's control. Therefore it will be considered an exogenous risk factor.
To read about the effect of inflation on the company's value, you can refer to this article.
As we explained in the article, the effect of inflation on the company's value is not uniform, but what is essential is that inflation can bring about a change in the company's value.
Systematic risk is measured using beta - which expresses the sensitivity of the company's situation relative to the state of the economy.
In this article, you can read about the beta and its effect on the value.

According to the systematic risk - there are two types of branches - defensive and aggressive industries. Defensive industries are industries that are less sensitive to the state of the economy. For example - branches such as insurance and basic food. It doesn't matter if the economy is in a recession or in flood - people will insure their homes and eat primary food products which they will buy at the supermarket.

On the other hand, aggressive industries are more sensitive to the state of the economy. Aggressive sectors include real estate, automobiles, tourism, and hi-tech. People buy electronics products, sophisticated computers, mobile phones, cars, and apartments during high periods. They go on vacations and trips around the world. In times of recession, on the other hand, people don't buy apartments. They use their cars longer, save the need to buy a new car, use their old cell phones for a more extended period, or buy less sophisticated phones and take fewer vacations.

What is the effect of systematic risk on value?

Remember the YCombinator rescission letter? In May 2022, YC advised its portfolio founders to “plan for the worst...cut costs within 30 days... get to Default Alive, Get money if you need it, and if you can, With or without money you must survive 24 months”.

This is not surprising. After all, startup companies operate in an aggressive industry. They expect that the recession will harm the high-tech sector.

How can you use industry type to produce a successful exit?

If you are starting a new startup - test which period this is - recession or tide. During a recession, you will establish a startup operating in an aggressive industry, while during a boom - in a defensive sector - such as insurance.

Conclusion

In this article, we have discussed the impact of Beta on valuation. Suppose you are looking for an easy way to evaluate your business, manage your cap table, or create a pitch deck. In that case, you can try our intuitive ai based business valuation software or our business valuation calculator, or you can contact us for free advice or schedule a demo.