Private equity (PE) firms have a problem most business owners would love to have:

They are sitting on somewhere between $1.2 and $1.9 trillion in committed capital, and if they don't spend it, their investors walk.

Adam Coffey knows this from both sides of the table.

He spent 21 years as a CEO running 3 national companies for 9 different private equity firms, bought 58 companies along the way, and exited for a combined $2.5 billion.

Now he coaches CEOs at roughly 15 PE firms, invests in their funds, and advises 68 founders (18 of whom are running buy-and-build strategies right now).

He recently sat down for an interview with Ronald Skelton on the How2Exit podcast to talk about the 2nd edition of his book The Private Equity Playbook, and the conversation turned into a field guide for anyone who wants to build a company PE will eventually pay for:

When Coffey wrote the first edition in 2018, he was working with 2017 numbers: $2.83 trillion in assets under management and roughly 5,400 firms.

As of the release of the book’s 2nd edition in 2024, the industry manages over $6 trillion across more than 8,000 firms.

By Coffey's count, half of all companies bought, sold, or financed worldwide now involve private equity, either directly, through a PE-backed strategic buyer, or through PE-funded debt. As an economy, he says, it would rank third in the world.

The practical point for acquisition entrepreneurs: whether or not you ever sell to a PE firm, private equity shapes the exit market you are building toward. And if you are trying to finance a deal outside the SBA or a big commercial bank, you’ll probably deal with private capital. Coffey calls private equity the world's largest nonbank lender.

Even so, most entrepreneurs don't understand how it works. Coffey says when he teaches a seminar to a room of a thousand business owners and gives a basic 10-question quiz on private equity, 90% still fail.

A private equity fund typically runs on a 10-year clock. The firm has 5-6 years to deploy the capital, holds each company for about 5 years, then sells.

Because firms put 6-8% of a fund into any single company (and never more than 12%), big funds buy big companies and small funds buy small ones. Coffey describes it as a pyramid with 5 steps, each about 5 years wide. You buy at one size, grow it for 5 years, and sell to the firm on the next step up.

Here is the pressure point:

Coffey is a limited partner in several funds himself, and he explains the LP's position bluntly. Investors commit capital but don't hand it over up front, because the fund's return clock starts the day it takes the money. So the LP has to keep that cash liquid and ready for years.

The stock market averages roughly 8% a year over 30 years; good PE funds return 16-20%. If the fund never calls the capital, the LP misses both returns. When the firm comes back asking for the next $5 million, the answer is no, and the firm goes out of business.

Coffey calls failing to deploy capital the cardinal sin of private equity. That's why the dry powder number matters. Firms must buy something.

"When I'm building a company, what I'm really doing is serving up a meal to private equity," Coffey says. The smallest funds need companies to buy, and he builds them.

Coffey lays out the odds: There are 34 million small businesses in the United States. Only 7% ever reach $1 million in revenue, and only 40% are profitable at all.

He says founders overthink startups. They chase the sexiest idea they can imagine and try to disrupt something, when a “boring company” in a “boring industry” makes plenty of money. Better still, you can buy one that has already been running for 10-15 years, pay fair market value, and know it works because it's still standing.

He's also seeing a shift in how people approach this…

Rather than buying one company, more of his clients are buying 2, 3, or 4, using the combined cash flow to service the debt, capturing some synergies, and selling the package. Most of the 18 buy-and-builds he's advising follow that pattern.

Coffey is clear that you can make money in almost any industry. He made a lot of it in HVAC. But when he's teaching someone new, he wants the odds stacked in their favor, and he uses a simple framework:

Needs over wants. In his family, his wife might want a new outfit, but they need the air conditioning to work when it's 110 degrees in Texas.

Recurring over project-based. A residential HVAC company that sells a system this month has to find a brand-new customer next month just to get back to zero, because the buyer won't need another one for 15 years. Coffey ran a large HVAC and refrigeration business and says he woke up every month not knowing where 80 percent of the revenue would come from. Compare that to a pest control company that bills 90 percent of revenue on the first of the month to credit cards on file and has the cash 3 days later, or a janitorial company where every new contract stacks on top of the existing pile instead of replacing a finished job.

Low capital expenditure, high free cash flow, fragmented market. Fragmentation is what makes the buy-and-build possible. He's currently working with a client in a $70 billion industry projected to reach $100 billion, but there are only about 200 companies in it and a handful control half the market. A strategic buyer will love that business. Private equity won't, because there's nothing to roll up.

The industries that check his boxes right now: bookkeeping and accounting, wealth management, independent insurance agencies, managed IT services, and contract-based blue-collar services like janitorial.

A common mistake Coffey sees: a small Texas company decides its second acquisition should be in Wyoming. His reaction was, in his words, "are you freaking nuts?"

Four small companies in 4 different states is likely more of a “collection” than it is an integrated business. PE buyers want to see a region, then a state, then a multistate footprint, then a 2nd region. The story has to make sense geographically.

Beyond density, the company needs what Coffey calls balanced growth.

A buyer wants to see organic growth (price increases, more contracts, more volume), growth through acquisition, and improving margins as the cost structure grows more slowly than revenue.

Coffey spent part of the conversation on economic volatility, and his conclusion for business owners was practical: stability is what businesses need, and when it's missing, you can't run as hot on debt as you might have when rates were near zero.

His rule is a debt service coverage ratio of at least 2-to-1. If the business generates $1 million in cash flow, he'll use no more than $500,000 to service debt. Think of it like buying a house with a 50%-down payment. Nobody with that much equity feels over-levered.

The SBA will approve loans at a coverage ratio as low as 1.2 to 1. Coffey's warning is that a 10-15% revenue drop, which could happen fast in a recession, can flip a 1.2x business upside down and force the owner to come out of pocket. At 2X, the same drop still leaves the owner taking distributions.

"Volatility is the enemy of growth, period."

Private equity has to buy. You can build what it buys. The formula Coffey has used across 58 acquisitions is not complicated, but most people skip steps:

Coffey is in his 60s and, as he put it, no longer has time for failure. So he only plays where the deck is stacked in his favor.

That's probably good advice at any age.

Watch the full interview here.

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