How do we stop Private Equity?

Hey 👋 - Brandon here.

Happy Saturday to 1,725 growth-minded accountants.

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This week, I saw a hot Reddit post (in r/Accounting) blasting private equity (PE):

First, I don’t think you “stop” PE and I doubt you want to anyway.

PE brings new liquidity options into markets. Firms can now trade more efficiently and at higher multiples than in years past which is a good thing in my opinion.

But that doesn’t mean you have to like PE.

Instead of “stopping” PE, let’s talk about how to “beat” PE.

After all, they are competing in the same talent pools, going after the same clients, and schmoozing the same M&A targets.

So how can you beat PE?

(By the way, I’ve built relationships with a few people running these funds in the accounting space and they are smart, really smart, and generally nice people as well. To be clear, this post is not meant to villanize anyone which I think is easy to do when talking about PE. Instead, the focal point of the message is how can you effectively compete against them).

First, Understand Their Business Model

PE primarily makes money on a multiple arbitrage play.

Here’s how it works:

• Fund 1 acquires a bunch of firms for 5-7x EBITDA. After 4-6 years of this heavy M&A activity, they sell to Fund 2 for 10x EBITDA.

• Fund 2 acquires several Fund 1’s for 10x EBITDA. After 4-6 years of this heavy M&A activity, they sell to Fund 3 for mid-teens EBITDA.

• Fund 3 is massive and likely has synergies embedded into its fund to enable all of the Fund’s businesses to cross-sell, boosting organic growth. Fund 3 may look to liquidate to an even larger fund or IPO to create liquidity.

An example makes it easier to understand:

You run Fund 1 and you want to acquire $10M of EBITDA which will enable you to sell the platform for 10x EBITDA. You pay $70M for the firms making up $10M EBITDA, you put corporate processes and team in place, and you sell for $100M.

You made $30M for your fund.

Now let me ask you this:

If you run a fund and your goal is to maximize EV (enterprise value), are you really going to make the necessary investments to grow a sustainable company?

If you know every one dollar of spend costs you ten dollars of EV, how motivated would you be to spend that dollar on labor, systems, tech, resources, leadership development, etc?

Especially as the fund nears the end of its life.

Remember, PE doesn’t get rich on cash flow.

They get rich on the exit.

Take a long-term view

I may be naive but I think a simple way to beat PE is to take a long-term view.

They are on a clock to go full cycle in 4-6 years.

You are not.

So build something that lasts.

• Invest in hiring great people and developing them to become leaders in your firm.

• Invest in the resources and technology they need to be successful.

• Invest in the coming AI revolution.

Focus on hiring people that PE leaves in their wake (there will be opportunities to hire amazing people) and setting them up for success at your firm.

And lean into fully serving the client: advisory, accounting, and tax.

Avoid building a firm that needs to be rescued

Many large firms are realizing they need to deploy capital to modernize and remain competitive.

But they also pay out ~90% of cash flow to partners… imagine trying to claw that back.

You think partners are going to vote for making less money?

The big firms are stuck (thanks to decades of building a bad business) and ultimately look to PE capital as a rescue option to restructure their balance sheet and business model.

Two ways to avoid this:

1. Don’t give up majority control. Every firm needs someone leading it that has unilateral power to make decisions and drive the firm forward.

2. Don’t let your partners get too fat and happy. Make ‘em sweat a little bit from time to time. It’s good for them.

Consider your marketing message

If you are strongly opposed to PE, I think in the near future it will make business sense build a firm around that message.

As the first PE funds liquidate, my guess is we’ll see growing resentment around PE-backed firms.

I’m not saying it’s right or wrong, but…

If you commit to never taking on PE and shout that loud and proud, I’d wager you’ll gain industry clout/reputation and access to strong talent as a result.

That's all for this Saturday. See you next week.

Cheers,
Brandon

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