Adam Coffey > Quotes

“Private Equity Evolution There is an old saying that imitation is the sincerest form of flattery. Pioneering firms had such massive success that it fueled the growth of more than 5,000 copycats over the last three decades. As a result, it should come as no surprise that the collective deal activity touching private equity has exploded right along with it. During the 1980s, less than 1 percent of merger and acquisition activity involved private equity. Today, it is estimated by EisnerAmper, in their 4Q 2018 PE Insights Report, that approximately 35 percent of all mergers and acquisitions completed in the United States in 2018 involved private equity and that within five years, that number is expected to eclipse the 50-percent mark.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“How the Private Equity Firm Makes Money Going back to our mutual fund example, oftentimes when you invest in an actively managed mutual fund there are management fees associated with that fund. Private equity acts in the same way. They typically charge a management fee of about 2 percent. Management fees are how private equity firms cover their overhead, not how they generate wealth. They generate their wealth through carried interest. Limited partners typically pay 20 percent of every dollar of profit back to the private equity firm. If as a limited partner you have $1 million invested, you’re being charged a 2 percent management fee every year for the capital that’s invested, and then when they sell a company, you pay 20 percent carried interest on the profit. Typically, there is a minimum rate of return that limited partners must receive, called the preferred return, before the general partner (the private equity firm) can charge carried interest and collect the fee. Let’s go back to the example of providing $120,000 of capital. When you got the $360,000 back, that included $240,000 of net profit. The carried interest charge, 20 percent, goes to the private equity firm and was already deducted prior to the distribution. That is their profit and where wealth is generated within the private equity world. These firms also invest in their funds. Limited partners want to know that the people working to invest their money have skin in the game. Therefore, private equity firms will create a subfund so their employees can invest their own money and coinvest alongside the fund every time the fund buys a platform company.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“Distributions to Paid in Capital The final ranking is distributions to paid in capital (DPI). The DPI measures the ratio of money that is distributed by the fund against the total amount of money paid into the fund. At the beginning of a fund, DPI is zero. As distributions are made, the fund breaks even with a DPI of one. DPI is more useful when comparing new or active funds of the same vintage, as the DPI will ultimately be near or equal to the MOIC after a fund is fully matured. On an active fund, the DPI showcases the velocity of how fast the fund is returning money to shareholders at the various stages of its ten-year life span.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“At the end of 1990, there were 312 private equity firms in existence. By the end of 2017, that number had grown to 5,391 firms with current assets under management totaling $2.83 trillion. With all those firms chasing deals, it’s no surprise that since 2006, there have been more than 43,000 private equity-backed company buyouts with an aggregate deal value of $4.249 trillion globally—more than half of those occurring in North America.*”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“The Importance of Outside Counsel As I mentioned in the introduction, it is absolutely imperative that you engage competent legal counsel and tax advisors. Law, like practicing medicine, includes generalists and specialists. Buying and selling of companies is a specialty area of legal practice. You’ll find most regional and larger firms have separate practices for business law with lawyers who specialize in transactions. While billing rates may be higher than a generalist, using a specialist is highly recommended when you are selling an asset as large and as important as your company. These lawyers are experts and very efficient at navigating the complex purchase agreements to be negotiated as a part of the transaction. Oftentimes, you’ll actually spend more per hour but less in total, because the experienced business lawyer will take less total time and deliver a more thoughtful, well-balanced document in the end. By the same token, using a competent accountant for tax advice can help you maximize the deal structure to limit your tax exposure and maximize the cash potential in the sale. Like attorneys, you don’t want to skimp on tax advice either! A top-tier accountant will pay for themselves in helping you plan for your windfall.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“Limited partners may consider the funds of 5,400 different private equity firms to invest in, so they need to have some means of knowing the difference between one fund and another. They may be considering venture capital funds, buyout funds, fund of funds, or different verticals, such as health care or technology. They may seek to build a portfolio of investments with different kinds of private equity firms and funds, but they need these rankings to help differentiate and as a critical point of consideration to make decisions on where to invest. As an individual, you’ll have a hard time finding these ratings without subscribing to an industry service. For our purposes, I just want you to know that these ratings exist and, with a little effort, can be accessed.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“Again, there’s no right or wrong; it’s just a matter of assessing what kind of private equity group you’re dealing with and if it’s a good fit. This is the time to be a little introspective about your own personality, how you like to operate, and how you want your future to look. There is an old saying among CEOs in private equity—“If your company isn’t performing, you are going to get lots of help. Want freedom and autonomy? Don’t require any help!” If you’re Josh and you have a very strong-willed, entrepreneurial, type-A personality, where you say, “Nobody’s going to tell me how to run my damn business,” you will probably not thrive in a full hands-on environment. Whereas a person who likes a collaborative effort that provides encouragement will do well with a full hands-on firm. Rose, coming from the Fortune 500 world, is probably used to being constantly pushed to do her job. She’s used to a high level of rigor and interaction with her boss and may actually prefer the style of a more hands-on private equity partner, but she should still assess her individual style and determine how she works best with others. “What would constitute a good partner for me?” No matter your role, you will most likely be an investor in this company, or at the very least the recipient of incentive stock, and you want it to do well. So if you don’t necessarily like hands-on, but the private equity fund is pushing you to excel and grow the company, it may not be a bad thing when it’s time to sell the company and get a payday down the road. Consider the professional athlete. They’re the best at what they do in a given sport, but they still go out and practice every day. They are constantly being pushed by coaches and managers to perform at a very high level, and to some degree, this hands-on approach is helpful to maximize their potential.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“Limited Partners Supply Capital The way a private equity fund starts investing is by issuing capital calls for the money it needs from limited partners. Here’s an example. You are an investor in a small private equity firm’s fund that is $100 million in size. You commit $1 million to the fund, or 1 percent. You don’t invest that money up front; rather, you’ve committed the capital, and as the fund seeks investments, it will issue a capital call when it needs the money. The private equity firm decides to purchase a company that has $4 million of EBITDA—discussed further in chapter 9, “EBITDA” (pronounced as three syllables: e-bit-dah) is earnings before interest, taxes, depreciation, and amortization. The firm buys this company for 8x EBITDA, or 8x $4 million, for an enterprise value of $32 million. Typically, when a private equity firm buys a company, they use the maximum amount of leverage or debt the cash flow of the company allows. In this example, we will use 5x leverage, so 5x EBITDA is $20 million of debt financing, leaving another $12 million of equity from that $100 million fund needed to complete the purchase. The fund issues a capital call, and as a 1-percent limited partner, you get a call that states you need to send $120,000, which is 1 percent of the $12 million of equity needed. This is the pro rata portion of the equity needed by the firm to purchase the company.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“Private Equity Means No Liquidity The private equity fund is made up of people committed to providing capital. They’ve signed up for it. They may not get their money back for ten years or more. The firm makes investments and issues capital calls to the limited partners. As a limited partner, you send in your portion to meet the demand for the cash that’s needed at the time. Because it’s private, there’s no liquidity, and a limited partner has no decision power. There’s no way to get your capital back on demand. This is typically why investment sizes are large. Private equity firms are not geared to handle nonaccredited investors who may need to get their money out quickly. The return of capital happens over time. Anytime a private equity fund sells a company or refinances for the purpose of creating a distribution, it returns capital to its limited partners. Using the same example as above, let’s say the company is sold five years later. Instead of the $4 million of EBITDA when it was purchased, the company now has $12 million of EBITDA. Earnings increased 3x over a five-year period. The company is sold for the same 8x multiple, only now the enterprise value is $96 million for something that they paid $32 million for five years earlier. That $20 million in original debt financing plus perhaps another $40 million in additional debt and transaction expenses (from buying add-on companies, legal fees, diligence fees, investment banker fees, and carried interest fees) leaves $36 million in equity remaining. As a 1-percent limited partner, you now receive a distribution from the fund for 1 percent or $360,000. The initial investment was $120,000, but your distribution five years later, net of fees, is $360,000 or a 3x multiple of invested capital (MOIC)—discussed further in chapter 2. This example shows how a private equity fund receives and distributes money. The capital calls are fulfilled as the fund makes purchases, not up front. In this case, the distribution from the fund back to the limited partner occurred five years after the initial capital call when the purchased company was sold. Many larger private equity firms often have multiple overlapping funds—some late stage and some early stage—operating with dozens of portfolio companies. Those companies aren’t all bought and sold on the same date. There’s a flow of money, mostly coming into the fund from limited partners in early years to fund platforms and then mostly being returned in later years as platforms are sold.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“next number”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“The most important ranking is the internal rate of return (IRR), which is the net return earned by limited partners over a particular period and expressed as a percentage (%). The calculation itself is very complicated, but at a high level, the number takes into account all of the various cash flows going in and coming out, including capital calls, management fees, carried interest fees, and distributions. The IRR is time dependent and uses the present sum of cash contributed, present value of distributions, current value of unrealized investment, and then a discount is applied. The IRR value is important to a limited partner because he is tying up a portion of money for an extended period, with the inability to invest that capital elsewhere. If the average rate of return in the stock market over time is 7 percent per year, then the limited partner is losing the ability to earn that same percentage if he was to invest in a total stock market index fund over an extended period. Thus, the IRR of the private equity fund better be higher than 7 percent net of all fees and carried interest. IRR is important, but you can’t spend it. It’s not cash! However, it remains the number one litmus by which private equity funds are rated. A good IRR is typically in the mid-teens, around 14–15 percent in today’s world net of all fees and carried interest charges. A great IRR is higher than 20 percent. Because there has been a huge growth in private equity, there is a lot more money chasing deals. Prices paid for companies have gone up, and the amount of return has gone down. Private equity firms are underwriting investments a little bit lower than they used to because of the competition. That dynamic can change over time, just like a buyer’s market and seller’s market when it comes to housing. There is currently nearly $1 trillion in capital looking for investments, but the private equity funds’ IRR continue to outpace typical stock market returns, and thus, the entire industry continues to grow.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“Oftentimes, the business owner looks at price and picks the highest bid. If your goal is to sell and retire, this may be the right call to make. But if you care about your employees or are concerned about legacy, you may want to dive deeper into the potential buyers. You should also consider sticking around and not fully retiring. It can be very lucrative to partner with private equity. You’ll get subsequent paydays when today’s buyer sells three to seven years from now. It’s possible to get secondary paydays that potentially can be even larger than the first, and if you are staying, price isn’t the only important factor; rather, it’s how the relationship between you and the private equity firm will be managed after the sale.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“The Hands-On, Hands-Off Meter Private equity firms run anywhere on the spectrum between full hands-on and full hands-off. I’ve worked with firms that are very hands-off, which means interactions were mostly limited to monthly phone calls to review financial performance and quarterly board meetings in person to delve deeper into how the business is performing and the various initiatives we were working on. The hands-off firm leaves me to run the business, and they mostly stay out of the day-to-day minutiae. That’s not to say they are out of the loop completely, just less intrusive. The private equity group consists of the financial experts, so they assist and add extreme value when it comes to capital structures and finance matters, but hands-off is more of a separation of expertise. On the opposite end, you have the hands-on private equity group. In these instances, I have experienced weekly phone calls with a subset of the board of directors. They provide me with to-do lists. In essence, they want to tar my bat and put my helmet on my head and tell me which pitches I should swing at.”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“The next number to consider is the multiple on invested capital (MOIC). This is simply the return divided by the invested capital. It’s a secondary measurement to IRR; however, this is the cash return. Whereas you can’t spend IRR, you can definitely spend MOIC. The difference is that MOIC does not take into account the hold period. If you invest $1 million and get a return of $3 million, that’s a 3x MOIC. However, it can take one year or ten years to see that return, and there’s no way to measure that impact with this particular metric. An investment that returned 3x MOIC in three years would have a higher IRR than one that returned it in seven years. Same cash return but a vastly different IRR. That’s why you look at both measurements!”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity

“How have your funds performed over time? Are your funds typically top quartile? How does your firm perform on types of investments like this company you’re recruiting me to work at? Can you walk me through your original investment thesis when you bought this platform company? Is the company performing to expectation? Is there incentive equity for key executives working at the firm? How does that incentive equity work under your various exit scenarios? Are there opportunities for me to invest? Beyond”
― Adam Coffey, The Private Equity Playbook: Management’s Guide to Working with Private Equity