Maximise Your Business Exit with Private Equity
If you’re a business owner planning your exit, private equity might be your most lucrative option. In the latest Exit Insights episode, Adam Coffey, author of The Private Equity Playbook, shares practical strategies to navigate the PE world.
Key Highlights:
- What PE Looks For: A strong leadership team, growth potential, and a clear succession plan.
- Rollover Equity: Selling a majority stake while retaining some ownership can lead to multiple paydays as the business grows.
- Market Impact: PE drives higher valuations across industries, making it critical to understand their strategies.
Quote: “Why sell a great company once when you can sell it twice or three times?”
Whether you’re looking to de-risk or scale to new heights, Adam’s advice will help you unlock your business’s full potential.
Show Notes:
- What private equity is and how it works.
- Key factors PE firms evaluate in a business.
- Benefits of partnering with PE, including funding and growth expertise.
Watch the episode here:.
Welcome to the podcast that’s dedicated to helping business owners to prepare for exit so you can maximise valuation and then exit on your terms. This is the Exit Insights podcast presented by Succession Plus. I’m Darryl Bates-Brownsword, and today I’ve got Adam Coffey joining me. Adam is the author of the Private Equity Playbook.
And I read that book last year. And so I reached out and thought, what a great guest to have on the podcast, because he could teach me everything I need to know about PE. And therefore, what benefits to you as a business owner who are thinking about one of your options of exit planning. If you haven’t considered private equity before, and it all sounds a bit big and scary, let’s tap into the source and figure out what it’s like, what are the experience from someone who’s been there and written the book about it. Welcome, Adam. Thanks for joining me today.
Well, it’s good to be here. Hello to all your listeners out there. It’s good to be here.
Excellent. Adam, why don’t you start and just give us a quick overview of your story. if you can do that in about four sentences, that’d be great because I want to get into the meat and bones of it. so.
Just to give the audience some insight of who you are and what set you up and what experiences you gained to be able to write the book on private equity.
Absolutely. So I think like this is sort set of experiences for us all. I was a soldier early in my life. Military taught me about discipline, teamwork, leadership. Engineering made me a meticulous planner. I’m a pilot. We don’t take off unless we know where we’re going. And we deconstruct the journey. Very useful skill later in life working with private equity. I spent 10 years in the Fortune 500 world working at General Electric. Tech didn’t exist at the time.
GE was the world’s largest company, number one on the Fortune 500 list. Jack Welsh is at the helm, the world’s most admired CEO. What a great way to learn how to run a business working at GE in the Jack era for sure. That led me to a 21 year career as a CEO, building three large companies for nine different private equity firms. So multiple owners. Buy it, build it, sell it, buy it, you know, keep building, sell, made 58 acquisitions during that time period, $2.5 billion in exits. I had been teaching at the university level and enjoying kind of the educational aspects. That led me to start writing books. I’ve had four number one bestsellers. And then I got bored and I just told the world I’m done being a CEO. I walked away.
And I started a consulting business, you know, really focused on helping founders beat the odds, find success, and then exit for maximum value. So I still work with private equity firms, work with about a dozen firms, work with 71 founder led companies all over the world, including the UK, Australia, New Zealand, Singapore, know, Dubai, you know, these companies are all over the place.
And I’ve been having a lot of fun. actually work more hours today than I did when I was a CEO. And so my mission in life, I’m 60, know, last 10 years of my career is to help as many entrepreneurs who are listening to this broadcast right now, find success and then monetise.
I’m just trying to think how you packed so much into your life. So, let’s start with the whole you’re the CEO.
I’ll sleep when I’m dead. That’s, how it’ll work. You know, until then there’s still stuff to be done.
Yeah, what is it when I go, I don’t want to go slowly. want that. We want them dragging me out, kicking and screaming and yeah. What a rush type of thing. So, so you’re the CEO of a, of a business, if I, if I recall. So, when you’re the CEO of one of these businesses did you own the business with your first PE experience?
So generally speaking…
What happened?
The PE firm is buying a company, they’re buying a platform. In my world, there’s two ways to get to where I got. Either you’re the guy that built the business and then sells it to private equity, or private equity is looking at buying a business, needs a leader. Maybe the former founder’s retiring or something’s happened. And so I’m the hired gun who came over from the Fortune 500 world, stepped into the CEO role. So I always was an owner in the companies that I was running, but I was never the majority shareholder.
Okay. So for people out there listening to this, if you’re the owner of a business, you’ve got a couple of options on the PE side of things. So we know you’ve got a stack of other exit options, but one of the ones is if you’re looking to sell the business or de-risk it, one option is de-risk it, get a PE in who will provide some funding. And if you’re the right person to keep growing and scaling the business, so you sell some to the PE firm, you keep some yourself, that’s one option, right? The other option is if you wanna go, you sell the business to the PE firm and they’ll find someone like yourself who was a hired gun and place them in to work with them as their agent, so to speak, to take the business to the next level.
And so when you think about that book, The Private Equity Playbook, there were two, two characters in the book. There was Rose and there was Josh. Josh was the founder who built a company, sold it to private equity, but stayed to continue to run it now as a minority shareholder. Rose was like me. I’m the original Rose comes out of the fortune 500 world and is recruited to come in and run a company. Once you’ve done that, both Josh and Rose are now the same person. And they’re in the same position. They’re a minority shareholder in a larger company owned by private equity. And the game begins.
384
All righty. So let’s let’s put ourselves in the mindset of the founder who’s going to sell to P.E. What is it that we can tell them today that PE are looking for so that they can rule out if their business that they’re running at the moment is going to be a good option to sell and use PE as their exit strategy.
Yeah. Well, it’s interesting you mentioned that because when I work with private equity firms today, I help them evaluate risk. So I help them look at founder led companies. I help them evaluate the investment potential as an operator, identifying the risks in the areas where, you know, we could get into trouble as investors. And when I’m working with founders, I’m on the other side of the table. And so I’m helping them eliminate the risk so that when the private equity firm comes calling, their version of Adam takes a look under the hood, doesn’t see risk. They see opportunity only, and they’re willing to pay up. You know, they’re willing to move very fast and pay a above market rate for the company because there is no perceived risk.
So in life, it’s all about risk. Let’s start there. So some of the things that private equity looks for, and first of all, I’ll tell you that you can make money in any type of industry, any type of business.
You can’t go through a 24 hour day in today’s world. Seven, you know, so at this point, private equity has passed the $7 trillion mark in assets under management. When I started running a company for private equity, it was about 800 billion.
And so they’ve gone in 20 some odd years from 800 billion to more than 7 trillion in assets under management. They have permeated every industry on the planet. You can’t get through a 24 hour day without seeing a logo that is a company owned by a private equity firm. So as an entrepreneur, even if you’re not considering a potential exit to private equity, be so thankful private equity exists because they’re buying 50 % of all the companies sold on the planet. As a result, they’ve created the market and the higher multiples that are being paid that allows you, even if you don’t sell to them, to monetise your business and maximise its potential in ways that didn’t exist 20 years ago. And so we all need to have a great working understanding of private equity.
But what private equity is looking for? First of all, they’re bringing money. They’re not bringing leadership. And so ideally, they’re looking for a leader and a team, a management team that is passionate about the company that they’ve built, about the industry that they’re in, that has excellent you know, insight into what the potential avenues that we could explore together, you know, with the private equity firms capital, you know, how could we grow this thing faster? How could we make it more special? You how could we generate, you know, outsized returns if capital was unlimited and never a gating item for you ever again? What would that plan look like to grow it?
That’s what they’re looking for. They’re looking for a business that has, I call it has legs, has room to run, room to grow. know, ideally they would like to buy a company that’s already growing at a, fast pace, potentially a company that, that they’re looking at it and saying, this company could be a platform, a platform in my fund. So, it’s a company I’m going to buy as an anchor.
And then I’m going to try to help that leadership team, help that business grow at a pace. It’s never grown before because it won’t be capital constrained. We’re going to look at doing mergers and acquisitions as a, an, ability to scale a business faster, very time efficient.
You know, the last company I built, bought 23 companies and put them together on top of the platform that I was running. And then the one before that, I had a platform and we bought 34 companies and put them on top. And so it accelerates the pace of growth. So, I need a fragmented industry, you know, in my perfect world, I’m looking for a company that focuses on serving needs, not necessarily wants that has recurrent revenue that has low capital expenditure, very high free cashflow, which lets me use the cash in the company to service the debt that’s required for me to buy the company. Ideally, I’m backing a leadership team that’s going to stay. They’re going to roll over a meaningful piece of the equity and keep on going with me now as the institutional shareholder behind them. And so, if the founder wants to leave, we need to make sure that, you know, they’re 70, they want to retire. We have to make sure that they’ve got a real team in place, that they’ve got a number two, that there’s somebody there to carry the torch with the private equity firm. And certainly there’s times where they would hire a CEO, someone like me to come in, but that’s risk. And so, if they could ideally find a leader that wants to stay, that has a great vision for the future, that’s ideal. Or they have a strong team and a good number too, so that as the founder walks out the back door, that team now becomes the people that are going to run with the business and go forward. So we have to be very thoughtful about succession planning. We have to be very thoughtful about what the different avenues for growth are. You the time to sell my company is not after I have a bad year. know, it’s, it’s ideally I’ve been thinking about this exit for the last two or three years. I’ve been working hard, you know, focused on growth because a growth company is going to sell for so much more than a stagnant company or a company that’s actually in decline. So it’s all about the story. It’s about the team. It’s about the industry, the total addressable market, the fragmentation, the ability for a PE firm to come in and deploy a bunch of capital and or leverage their debt relationships and have just an outsized ability to grow this company at a very fast pace because they have a limited window with which they’re going to own the company, typical hold periods about five years. And they’re looking to, to triple or quadruple the size of the earnings in about a five year period, which means a lot of work has to happen very quickly. And a lot of capital is going to get deployed or debt if we’re buying companies. And, you know, I need a team that can make this happen. That’s, know, that’s kind of the mindset of the private equity buyer.
Mate, you’ve covered so much there. So let’s try and recap it a bit just to pull it into play. One of the things that the PE firm is looking at is they’re investing in the leadership team of your business. If you want to exit, you’ve got to make sure you’ve got a.. you’ve built some depth into your business. So, you’ve got that leadership team and ideally a number two as well to fill the hole left by yourself. You’re looking for a business that’s got a track record of growth rather than one that’s plateaued or stagnant. You’re looking for a potentially, depending on where the private equity fund or team is in terms of its cycle, they’ll either be looking for a platform business which would start a movement.
And that platform business would become, I guess, the cornerstone of which they’ll use to leverage and they’ll use a whole lot of &A to bring in other acquisitions in the same industry to build a bigger business in that industry.
And so on that point, just real quick for the larger companies that were that are listening to this podcast, they would be potentially of platform size. But if I’m a smaller business, that doesn’t mean that private equity isn’t potentially a viable exit. A smaller business could be targeted by a larger business that’s backed by private equity, and they could be a potential add on acquisition to an existing platform that’s backed by private equity. So, even small businesses have potential private equity exits.
Okay. So, while we’re touching on that, Adam, how did, does a business have to be at a certain size before a private equity business fund will be looking at them? Because I’m guessing that they’ve got the same amount of work to do in terms of research and due diligence. They’ve got the same amount of cost to evaluate a business of of any size. So does it need to be a certain size before they’ll consider it?
So there’s tens of thousands of PE firms in the world.
Yup.
And like any other industry, they come in different shapes and sizes. We have really big PE firms like KKR, Carlisle, Apollo, EQT, you know, in Europe. And they have huge funds and big firms with big funds by really big companies. But you’ll also find small firms and small family offices. You know, those biggest PE firms, they may have fund sizes of 10 to $30 billion in size. At the bottom though, you may have a family office or a PE firm that’s investing with $50 million in a PE fund. Interestingly enough, they all do the same things.
Yeah.
So those funds typically will invest six to 8 % of their fund size into one company and never more than about 12 % for asset diversification kind of rules. And they’ll typically hold it for about five years, which means a little firm buys a little company and for their five year run, they make it bigger. Now they sell it to a bigger PE firm that’s going to own it for another five years and take it bigger. And I could show you, you know, there’s, literally what I call five layers of capital in the world of PE. And you could go from startup to public company and be bought and sold by five, you know, five different times from one PE firm to another as you’re getting bigger. And so there is an ecosystem.
And so, if I’m a small firm, I’m looking for small companies. If I have a small company, KKR is not walking in to buy me as a platform. That’s not going to happen. So my focus as a business owner is to understand where and based on my size, what is my likelihood? And what type of an exit, what type of a firm might be interested in me. And so I generally tell people, if you have 4 million in earnings, you are a fabulous target to be a platform company for what I’m going to call a lower middle market PE fund, you know, or firm. And if you’re 10 million, you know, that’s another inflection point where larger funds come in and look to buy. So you’ve got like 4 million of EBITDAs where the first level of real PE firms are coming in. If I only have a million, you know, I could still be a platform for one of these micro firms, but they may or may not be a great partner for me. But certainly I could find an exit at that level. But I’m probably going to be happier if I’m an add on acquisition to a larger strategic if I’m if I’m a million dollars in earnings and if I’m hundreds of thousands in earnings.
I’m almost always guaranteed I’m going to be an add-on acquisition to something that’s bigger. So people are either building it to get it to somewhere between like four and seven million of earnings, or they’re building it to get to 10 to 17 million, or they’re building it to get to 40 to 60 million. And it’s kind of like, these are the three points most entrepreneurs listening to this broadcast would have some ability to build a company and target.
Below, you know, that 4 million, you know, that, that real platform kind of entry size where I’d get a really good firm, really good partner.
I may be an add-on. may be a platform to a really small company, but understanding how PE works and understanding these different sizes and kind of lines of demarcation, very helpful for an entrepreneur to understand, Hey, when my phone rings, who, who is a call I should have and who’s a call I should simply pass on.
Yeah. So, what you’re telling us here, Adam, is that whereas any business of let’s call it an established business that is actually a business rather than just a lifestyle business that’s making some money for a few people. But any business has got a management structure in place and you start to build those at about a million or so in size. You’ve got 15 people in a business. You’ve got some structure in place. That is PE is a potential exit strategy for you. If it’s the right fund and if they’ve already got a platform business, you might be an add on to their business. what you touched on earlier, I just want to check that I heard this correctly, is that we can be thankful to private equity funds for some of the high evaluations we’re getting out there because they’ve grown so much and their thirst for acquiring businesses. Is that correct? That’s correct. That’s correct. A lot of entrepreneurs, they think of selling their business.
That’s correct. That’s correct. And so, you know, a lot of entrepreneurs, you know, they think of selling their business as a one and done event.
Yeah.
I’m going to build it. I’m going to spend a career and then I’m going to monetise it. And then I’m going to walk away. And what I tell people that are listening is why sell a great company once when you can sell it twice or three times. My personal record is selling the same company five times in 13 years, you know, and sell it twice or three times. First of the is selling the same company five times in 13 years.
And so, you know, if you’re an entrepreneur and you look at an exit as the end, you get a wheelbarrow full of money, you go to your garden and it’s like, and I bury it, but now what do I do, you know, with the rest of my life? I have to start something new because I’ve got a non-compete in the company and industry I just left. Why not stay? Why not take, you know, 70 cents of every dollar off the table and reinvest it elsewhere for diversification? Why not roll 30 % forward, become a minority shareholder backed by private equity and then let’s build it again and sell it again, because one of the joys of private equity is the fact that their hold period is going to be, you know, call it on average five years, which means I’m going to get a payday every five years. So, if I build a company for 20 years and I sell it, I get one payday and I’ve got 20 years worth of risk with a lot of my net worth tied up in my business where I could sell it today, sell it five years, sell it at 10 years, sell it at 15 years, sell it at 20 years.
I could get four paydays during that time period, getting asset diversification every time it’s sold. so I look at private equity looks at us entrepreneurs. I’m an operator. build companies. Private equity looks at us as a tool. It’s a tool to take their capital, invest, grow, get returns, return to shareholders. I’m a tool for them. We need to look at private equity as a tool for us, you know, for, for business owners. And so, the more I understand how it works, the more I can manipulate its own nuances for my advantage, you know, and put that to my advantage. And so, you know, we need to become more educated. Here’s a scary statistic I’m going to give you. I teach seminars all the time, you know, on private equity, on scaling companies, doing M&A, exiting. And if I start a seminar and I give, you know, a room, you you put a thousand business owners in a room. These are sophisticated people. They’re all wealthy at some level. If I give them a basic 10 question quiz on private equity, that’s multiple choice. I promise you 90 % of the room will fail and they’ll fail miserably because although we’ve heard the term, so few people truly understand the basics of how private equity works. And when you know how it works, you can tap into it, feed it what it needs which is growth, take from it what you want, which is wealth creation when that company is sold and monetised. And so I think that we as entrepreneurs, whether we think about private equity exits or not, we really need to get more educated, which is why I wrote the book in the first place. You know, the, private equity playbook was number one this morning on Amazon in the US I wrote it five years ago.
You know, the second edition, you know, also is out there now. But, you know, it’s like, we need to learn about this tool in order to understand when the phone rings. What’s the world behind the phone?
Look, as I’ve read the book and for anyone listening to this, I would recommend reading the book. It is it is nice, simple language. So for someone who’s curious about private equity, Adam doesn’t use complex language. He makes it really easy to understand. So using that, Adam, you know, what I’m loving is, is if we get on the front foot, private equity is a great way to partially de risk.
A lot of business owners I talk to, they’ve built their business over a number of years and it’s their biggest asset. It’s grown in value far greater than their house or any other assets. And a lot of them are sort of going, well, I’ve got a lot riding on this, I need to sell it. But you don’t have to do it that way. If you find the right private equity fund is what I’m hearing is what we can do is partially de-risk. And what we’re then doing is bringing in a funding partner for the next part of the journey.
And often they don’t just provide funds, they’ll often provide assistance as well to bring in some additional resources to help you accelerate that growth and scale.
So, two things I want to mention that you just touched on before I forget them. So I write for Forbes every month. And one of the articles I wrote last year was called when’s the right time to sell my business. And I created this thing I called the rule of 130. So, you take your age as a two digit number. I’m 60. I write down six zero. And then I look at that asset, like you just said, and I say, how much of my total net worth is tied up in this illiquid thing known as my private company. Write that down as a two digit number. When I’m working with founders, oftentimes that number is 80, 90% of their net worth is tied up in the business. Then I take their age, add the two numbers together. If it’s higher than 130, you are assuming too much risk and bad things happen. So, I’m working with a business right now in the UK.
And he’s doing a roll up in the machining space. So five axis CNC milling, you know, kind of metal shops, you know, and their largest client was a customer in Russia. And when, when the war between the Ukraine and Russia broke out, the UK government turned off all exports to Russia. Well, this guy wasn’t making components for bombs, you know, or anything to do with the military. But immediately his largest customer and his access to that largest customer was cut off and it was like 40 % of his revenue.
And so, then he and I just spent the last year trying to read, you know, kind of read structure this company so that it could survive long enough to find additional revenue streams that could make up for this. And that war is still going on. We thought this could be an eight day war, and we’re talking years later, it’s still going. risk happens, planes fly into buildings, war starts, pandemics happen.
Bad things can happen to your business. So, you need to be conscious of risk. One last thought I want to share. As we get older, inherently in our minds, we know that we’ve got a lot of risk in our business.
And so what an entrepreneur typically does is they stop making good business decisions on growth. They stop betting on the future and they start slowing down the rate of investment, which means the growth of their company starts to slow down and plateau. Then they wake up one day and say, okay, I need to sell my business. But now for the last three years, they haven’t been growing and they have completely hurt the value because they weren’t doing the things that made them successful in the first place because they knew they had risk. And so, you know, when I’m thinking about this kind of stuff, logically, you know, as I’m getting older, I could say to myself, “hey, it’s time to bring in a partner. It’s time to get some chips off. I’m going to use their money. You know, if I’m a Vegas, it’s like I’m playing with house money. Now, I’ve got 70 % of my wealth out and I’ve rolled 30 % forward and I’m going to work hard now with them to get a second bite of the apple.”
So, let’s just slow that bit down. As a business owner, you might sell 70 % of your business to the fund and you keep 30% and that’s what you’re calling the rollover. So, you’re going, hey, I’m still in the game. I’ve de-risked. I’ve got some money out of extracted. I’ve put it in my pocket. But OK, so I can take a sigh of relief because I’m not feeling all that exposure anymore. I’m probably going to relax a bit more. And now I’m ready to go again.
And I’ll be aggressive because I’m using someone else’s capital now to keep driving my business forward. So that is kind of the basic gist of it. And there’s a lot of people out there listening who would say, know, know, Darryl, there’s no way I want to be a minority shareholder, you know, that has to answer to some snot nose punk smart kid, you know, in New York or London, you know, I’m not going to do that, you know, and, I always come back with two names and I say, what about Jeff Bezos and Elon Musk? The two wealthiest men on the planet own less than 13 % of their respective companies. If they can be a minority shareholder and make a ton of money, so can you.
And so we have to change our mindset in thinking and understanding. Because when we do the math on these potential rollover investments, typically what happens is, know, I’m shooting, the world of private equity is shooting for a three to four X multiple of invested capital. So, if I’ve rolled over you know, 30%. If I get a four, you know, a four times return, then I get 120%, which is actually bigger than the original 100 % I sold my company for. So in my history, second bites are bigger than the first third bites are bigger than the second. It’s like, man, you can make a ton of money by de-risking and your healthier position in case something bad happens like a war, a pandemic, or any number of other things.
And I’ve got the diversification, but I still have the ability to get additional paydays that are exciting, that are bigger than the last payday I got. One thing I want to correct though, the reason we need to sell a majority share of our company is that the largest pool of capital in private equity is in what’s known as a buyout fund. And so, a buyout fund. It says right in their prospectus, right in their charter, you know, they tell their shareholders upfront, we will have a controlling stake in every investment we make. That is the biggest pile of capital. If an entrepreneur says, I don’t want to sell a controlling stake, I’ll sell a minority stake. I have just eliminated the largest source of potential capital on the planet. And it’s a very small subset of private equity firms that will do a minority investment. And those, you know, typically are still going to control you because their shareholder rights agreement is going to give them the power to talk about exits and to control certain decisions that you make. So you think you’re staying in control. You’re still going to cede control on certain items, but in reality, you’ve also eliminated the largest potential pool of buyers and the multiple that you’re going to get for the more minority stake is going to be much lower because there’s not as much competition for that minority investment. So many different little nuances here that you need to understand as a business owner.
So, the general gist is if I sell, if I play the private equity game, I’ll build my business up to a point where it’s sustainable and stable, and I’ve got some succession strategies, so I’m established in the marketplace. I then become an attractive option for private equity to either want to invest in my business as a platform or as an &A to a platform they’ve already acquired. I will sell a big chunk of my equity and I will keep some of my equity and I’ll roll it over into this fund, which I’m going to ask for a bit more on in a sec.
But I’m keeping a chunk of my equity. So then I’ll grow it because I’m now part of this bigger business and I’ve got a role in this bigger business. So, I’m getting some career growth and I’m alleviating any career board I had in my smaller business. I’m playing a bigger game. I’ve got a smaller piece of equity. The whole fund’s objective is to sell that or grow it by three to four times in five years. I’ll get that and then we might sell to another private equity fund.
And I have the option of going, can sell either all my equity I’ve got remaining or I can sell a chunk of the equity, get that second payday and still keep a chunk and roll and play again. And that’s, we can call that the private equity game, I guess. And that’s how the fund works. Is that, and is that what you meant when you earlier said you had five?
That’s it. You’ve got it right, but just one technical correction, and that is I’m going to sell 100 % of my company every time. But what happens is, is when I sell it, I roll 30 % of my proceeds into the holding company that they’ve put in place to buy my company. And there’s a technical reason why this is important to you to do that. So I sell 100 % of the company. They have bought my company. I roll over 30%. The private equity firm and I now own the same stock in this holding company. Now they’re going to go out and if they buy 10, 15, 20 companies, all of those, those assets are being rolled up into the holding company. And so, you know, I am now getting what’s called multiple expansion and multiple arbitrage. And so, let me explain that real quick.
There are millions upon millions of small companies in the world. I’ve got some quick statistics just for the US. There’s 33 million small companies in the US, but there’s only 3,000 companies on the entire planet that have a billion dollars in revenue. 2,000 of them are public, 1,000 are private. So if I took all the companies in the world that are small, it would be hundreds of millions of companies that are small. Still only 3,000 at the top that have a billion dollars in revenue globally, which means that as we get bigger, we’re rare. We’re very quickly becoming rare. And the value that someone pays for that rare company, remember big PE firms with big funds only by big companies, but there’s not enough of them to buy. And KKR can’t take a $30 billion fund and go buy small companies. would take them a thousand years to put the money to work. And they only have six years in a 10 year fund life to put their money to work and their average hold periods five years. So big firms buy big companies, not as many opportunities. So by aligning myself with the PE firm and we’re both owning the same stock, now as they’re buying other companies, I’m getting a piece, they’re sharing with me a piece of that multiple expansion, multiple arbitrage. So let me give you some quick numbers. Last company I built, I bought 23 companies. I paid on average five times earnings for each company. Each company had roughly 2 million in earnings. I paid five times. I paid $10 million per company. I bought 23. When I sold it, I sold it for 14 times. So, a dollar of earnings that I paid $5 to buy, I now sold for 14. The 14 minus the five equals $9 of profit. That comes from the multiple expansion. That’s the arbitrage, which is the difference between what I paid and what I sold for. This is a naturally occurring phenomenon. This is the number one way private equity firms make money, which is why you always see them buying a company and then buying 20 more companies and throwing it on top. Is they’re trying to build something bigger that is above the pack of small companies that will trade for a higher multiple and they’re making their money on the arbitrage, the difference between the price they pay and the price it sells for when it’s a bigger company at a higher multiple. That in very quick terms is how private equity firms make their money. And you’re getting to participate in that when you’re a small business owner who is rolling over. And instead of owning 100 % of one watermelon, you now own a small percentage of a truck filled with watermelons. And there’s more there for you at the end.
Thanks for that, spelling that out, Adam. That’s brilliant. think you, well, you didn’t include the other part of the uplift you get. So you only discussed the arbitrage there. But as the business grows, you get economies of scale and growth as well.
Absolutely.
So the other side of the valuation equation, the profit increases as well. you get that double, triple whammy, don’t you?
You do and to sell it for maximum value. I don’t want to oversimplify it. It’s not just about putting companies together and getting big. You also need good organic growth. You need to be improving the margins getting that uplift you’re talking about. If I have all of those components present, I’m going to trade for an extremely high multiple, but it can’t just be an &A game. It also has to include those economies of scale. It has to include, you know, increases in revenue organically and oftentimes the M&A leads to what I call cross-sell. So I’ll buy, I have certain products and services that I provide. A company I buy has similar, but maybe slightly different products and services. They’ve got customers, I’ve got customers. I sell their customers what I do. I sell my customers, what they do that’s different. And it’s like this cross sell opportunity accelerates organic growth which I’m now getting a higher multiple on when I sell. And so as a result, it’s like all of these things is like a symphony of opportunity that’s being played out very quickly in a five year period.
A symphony of opportunity. I love it. So, and we’ve pulled it together all very quickly. There’s just. I think I’ve really appreciated the way you’ve spelled out how the private equity game works. Can you give us an overview, Adam, of we’ve touched on it a couple of times and we’ve talked about the P.E. fund. So, the business owners understand how the I guess the fund, how does the fund work when they put that together?
So you have a firm, think of the firm like a bank. It could be public or private. The bank then gets money from investors, and so your money in a public bank is not public, it’s still private. So, private equity, the reason it’s called private is because it aggregates money from a number of investors. It creates a fund which has no liquidity. The fund lasts for 10 years. And so investors who invest, know, typical minimum size investments, 5 million. When I invest in a PE fund, you know, I’ve got this vehicle. a financial vehicle that lasts for 10 years. And at the end of 10 years, I have to return all capital back to the shareholders or
the limited partners, the investors, the people that gave me the capital. So I have a fund in the first six years of the fund. I can go out and make investments.
And when I buy a platform company, which is one of the anchor holdings of my fund, that company then becomes one of the cornerstones. I may have eight to 15 cornerstones in one fund because they, they invest six to 8 % of the fund in one company. Never more than 12. It’s probably going to be anywhere from eight to 15 companies owned by one fund. When they have those cornerstones, they now put a bunch of other companies on top of all the cornerstones to build up their platforms as they’re maturing, as the clock is running out on their timeframe, they are then, you know, forced, they have to sell, they have to sell because they have to return the capital back to their limited partner investors. And so, this phenomenon, what you’re doing when you’re investing, you’re not becoming an investor in the PE firm, you’re becoming an investor in a company owned by a PE fund. The fund is managed by the firm. So if I think of a mutual fund, you know, a mutual fund aggregates investors money, you know can go on Charles Schwab and buy a mutual fund today and you can over there in the UK, we can put all that money together, they go, you know, a fund manager goes out and buys a basket of stocks. And I can sell that fund.
You know, today, tomorrow, hold it for 10 years, whatever I want to do. The difference here is the investors are putting the money into the fund, but there’s no liquidity. They’re kissing it goodbye for up to 10 years. The fund manager is the PE firm. And so they have their team of professionals who are then going to take that capital, figure out what companies to buy, what the investment strategy is. And so I’m kind of riding the coattails of what’s the world’s most sophisticated asset class.
And why has private equity grown so much? Well, it’s not because they suck. It’s because their returns are more than double on average, the S &P 500 or the MSCI World Index. And so if I’m investor, a person investing in the stock market, know, index fund, I can expect the market, I’m going to earn 8 % per year over an extended 30 year period of time. That’s kind of the return of the markets.
If I’m in private equity, I’m going to get 16 to 20 % return in that same kind of time period per year. So the reason money pours in is because those investors are getting double the stock market’s kind of returns. Andthat’s what’s fueled over the last 25, 30 years, this large inbound flux of capital that’s caused private equity to go from about 800 billion when I first started.
Wow. Hey, thanks for that. So one last question, if I may, is the people who invest in the fund. They’re not doing it just to get their capital back in 10 years time, are they?
No, they’re, they’re wanting it at an outsized return. So, the largest investors in private equity are pension funds. So, companies that have pension obligations for their retirees, you know, and they have large pools of capital and they need big returns in order to keep funding, you know, as we’re living longer, you know, those retirees are getting more money, you know, so it’s like they need that return. And then it’s also university endowments.
And so large, large colleges and universities that have private endowments, know, money’s being collected from alumni, you know, people who are donating, you know, and they are, you know, they and public pensions are the two largest, you know, groups of investors in the world of private equity. And then you’ll have wealthy families, you know, and, potentially even private companies, but, people who will invest in private equity. But the majority comes from those, those two sources.
And what do they want? They want returns and they want double what they could get if they just put it in an index fund. And so that’s the game of private equity is generating outsized returns for investors so that they keep giving you more money for your next fund.
Adam, I appreciate your time. You clearly know this topic inside out. And for anyone listening to the podcast, I’d recommend you buy the book and get a copy because there’s so much more information in it. But before we end, Adam, I always ask my guests, what’s the number one thing that you would love listeners to take away from our conversation today?
Do not be afraid of the unknown. We listen to the news. The news always tells us about bad things going on in the world, never about good things going on in the world. So, many of us have a negative bias towards private equity. Private equity is a tool. It’s a tool that we can use or we can benefit from. Get inquisitive, learn about the world of private equity because it has a direct impact on the valuation of your company, whether you plan to sell to them, partner with them or not.
You need to understand how the world’s largest source of non-bank debt and the world’s largest buyer of companies, you need to have a basic understanding of how that works so that regardless of what your future plans are,you understand and can learn how to kind of work within the framework. Because even if I don’t sell my company, if private equity has come into my industry, they’re rolling up my industry. How is that going to change the landscape for me, even if I’m not selling?
You know, I need to understand the game being played so that I, as an entrepreneur, am better equipped for the next 20 years. And so that’s my thing. Don’t think you’ve ever stopped learning. You know, as an entrepreneur, we need to keep on learning. This is a topic we need to learn about, even if we don’t plan to sell to it.
Brilliant. Adam Coffey, thanks for sharing your exit insights with us today.
It was good to be here. Good luck to all your listeners.
About Adam Coffey
CEO, Board Member, Best-Selling Author, and Acclaimed International Speaker, Adam Coffey is a visionary leader who drives transformative growth and fosters high-performance cultures.
With 21+ years of experience as CEO, Adam built three national service companies for 9 private equity sponsors. During this time period he completed 58 acquisitions, his track record includes notable outcomes measured in the billions, averaging 5x MOIC at exit.
Adam is a respected mentor to MBA candidates and a sought-after speaker at top business schools. He brings diverse expertise from commercial and industrial service businesses, alongside being a licensed general contractor, pilot, former GE executive, and US Army veteran.
As an author, Adam’s books “The Private Equity Playbook” (2019), “The Exit Strategy Playbook” (2021) and Empire Builder (2023) all became #1 Amazon Best Sellers. Recognized as one of the “Most Influential Leaders” by the Orange County Business Journal, he founded the CEO Advisory Guru in 2021, providing consulting services to private equity firms, their portfolio companies and to founders.
Adam’s impactful seminars have generated millions in revenue, solidifying his position as one of the world’s top speakers. He resides in Westlake, TX, with his family.
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