The “Exit Strategy” of Private Equity By Curt Taylor Suppose that you are running your own Private Equity company (set up using my previous guidelines). You run out the cash flow on one of your large investments and you find that the rate of return is 2%. This is not a good thing since you are already charging your investors a 2% management fee (to get rich) and that would leave zero for investors. What you need is some way to bump up the “valuation” on this deal. Below I will share a few tricks of the trade to use. Let’s use an example to illustrate. For my example I have randomly picked making an investment in a port in, let’s say, some South American country. Here is what you need to do: 1. The Investment. The first thing that you do when making a port investment is ask everyone on the investment committee whether they have ever done a port investment. No one will usually raise their hand… and that is a good thing! If someone had done one, they would know what a long-term risky bet that it is and possibly derail it. If there is someone, either fire them or ship them off to a distant Asian office and disconnect their phone. This makes a perfect investment because no one will have a clue about what the reality is. Also, you need to make this a “BIG” investment, like say, a billion dollars. This accomplishes two things. First, you get a lot of attention for making this huge investment and people will say stuff like, “Wow”. Also, your investors will be thinking that if you are investing A BILLION DOLLARS… it must be a good investment! Surely, you’re not that stupid! Meanwhile you are earning your Management Fee on their billion dollars. 2. The Risks. This is an area that you really need to stay away from. This puppy is riddled with timing risks and market risks and customer risks and country risks and foreign currency risks and on and on and on and frankly you really don’t understand them because you’ve never done a port investment. You will hear people say things like, “this could take a lot more time and a lot more money than you think”. Ignore that crap. You can’t get rich listening to naysayers. These people are not getting the Management Fee. 3. The Profits. So, here is a little bit about ports. A port is basically a piece of land on the ocean. You want to build things where “customers” can store their items until they are shipped out of your port. Things like iron ore, or coal or oil or bunnies for that matter. You, as the port owner, will earn a fee when they store their items on your property and another fee when you load their items onto the boats. Most of your customers will be large trading companies that have done this for years and have large shares of the market and will beat the snot out of the fees you want to charge them and all of this is to say that the “profits” (very illusive term) may be small and take a very long time to increase. The other problem is that all the customers will want you to build things for them that will all require you to invest more of your money (or capital as we capitalists like to call it). 4. The Complex Financial “Structure”. As the project moves along and you suddenly realize that you have to put more money in on top of the billion you already invested (it takes money to make money), you will need to have a complex financial structure. Instead of just putting another $100 million in the deal, you loan the money to your company so that it looks like an incredibly safe loan (why…cause there’s already 1 billion invested). Now, instead of just looking like you have now invested $1.1 billion, which you have, it looks like you have a billion dollars invested and a super duper loan as well! The more complex that you make it, the less obvious it will be that you are just investing more money. You could even have multiple “tranches” of debt to put additional money in, which will probably be needed. 5. The Valuation. After you get going, you now get your “analysts” to “run the numbers”. Remember, these are “analysts”, which basically means they are nobodies and are lucky to have a job and have NDA’s signed so they can’t tell anyone the truth about these numbers. When they bring you back the numbers, you look at them and say, “crap”, because the numbers say that if you run out the cash flow your investors will be lucky to get their money back. This is not what you tell anyone. This needs to be fixed. 6. The Big Fix. When your analyst gives you the graph of the profits it might look something like this: This sucks, so you tell the analyst that their “assumptions” are all wrong and you send them back with new assumptions and they come back with a graph that looks like this: Sure, these assumptions are slightly more optimistic but, what the heck, they’re only assumptions right? The truth is that any assumption is going to be wrong so why be wrong and look stupid? The beauty of this is that you can make the “assumptions” whatever makes it look good. 7. The Bigger Fix. You ask the analyst what the return is now, and they say 10%. This still sucks because you have told the investors that this deal is “awesome” and they are going to make a ton of money and 10% is not a ton. What to do? Here is another PE secret, the “exit strategy”. You tell the analyst to take the last year’s profit number (year 2029 profits on the graph) and “assume” you sell the lousy port for something like 20 times that (the “multiple”). Suddenly this has a 100%+ rate of return and you make $4 billion! That’s called a “4 bagger”. PE guys like to say bagger because it reminds them of golf which they do a lot. The beauty of this is that you can make the “multiple” whatever makes it look good. 8. The Big Reveal. Suppose that the actual numbers look more like what the analyst originally came up with (note to self: may need to fire that guy). The beauty of this is… it won’t matter! You just push all the numbers out another year, every year, and you might have to raise a few assumptions and maybe increase the “multiple”, but you can do this for years before anyone catches on to the make believe “assumptions” and “multiples” you have used. And there it is. These tools above should help you to fix any investment that you have done. Using numbers can be overly complicated. People don’t like math. Remember that the more obscure the investment, the more complicated the financial structure, the more numerous the assumptions and multiples, the easier it is to take something which gives you a HUGE amount of attention and milk it long enough till it slowly goes into the night and disappears, like the corona virus.