About this episode
Adam Coffey spent 21 years as a CEO of three national service companies backed by nine private equity sponsors. During that time, he completed 58 acquisitions and generated more than one billion dollars of value at exit.
Adam’s book, The Private Equity Playbook, is a bestseller, and on this episode of Built to Sell Radio’s “Inside the Mind of an Acquirer” series, Adam teaches a masterclass on how private equity works. You’ll learn how to:
- Become irresistible to a private equity group.
- Avoid becoming a bottleneck inside your company.
- Optimize your pricing.
- Negotiate with a private equity group.
- Grow your business organically.
- Evaluate the creditworthiness of your acquirer.
- Perform reverse diligence.
- Calculate your debt coverage ratio.
Show Notes & Links
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Definitions
Due-Diligence: This is a comprehensive appraisal of a business or investment undertaken before a merger, acquisition, or investment. It seeks to validate the information provided and uncover any potential risks or liabilities.
Earn-out: This is a financing arrangement for the purchase of a business, where the seller must meet certain performance goals before receiving the full purchase price. It reduces the buyer’s risk and aligns the interests of both parties post-acquisition.
Roll Over Investor: A rollover investor, in the context of selling a business, refers to an individual or entity that rolls some of their proceeds from the sale with the buyer. This strategy allows the seller to defer capital gains taxes and potentially leverage their expertise or resources in a new venture.
Debt Coverage Ratio: The debt coverage ratio is like a financial health check for a small business applying for a loan from a bank. It shows whether the business earns enough money to comfortably cover its debt payments.
In simpler terms, it’s a way for the bank to see if the business can afford to pay back the loan. If the ratio is high, it means the business is making enough profit to easily handle its debts. But if it’s low, it could indicate that the business might struggle to make loan payments, which could make the bank hesitant to lend them money.
Let’s say there’s a small bakery called “Sweet Delights” that wants to expand its operations by taking out a loan from a bank to buy new equipment. The bank wants to make sure Sweet Delights can afford to repay the loan, so they calculate the debt coverage ratio.
Sweet Delights’ annual net income (profit) is $50,000, and they have annual loan payments of $20,000 for existing debts.
The debt coverage ratio formula is:
Debt Coverage Ratio = Net Operating Income / Total Debt Service
In this case: Net Operating Income = $50,000 (annual profit) Total Debt Service = $20,000 (annual loan payments)
So, the debt coverage ratio would be:
Debt Coverage Ratio = $50,000 / $20,000 = 2.5
This means that for every dollar of debt Sweet Delights has, they’re making $2.50 in profit. In simple terms, the higher the ratio, the better, because it shows that Sweet Delights is making enough money to comfortably cover its debt payments. This would likely make the bank more confident in lending them the money for the new equipment.
Arbitrage: Arbitrage refers to the practice of exploiting price differences or inefficiencies in the market to generate profits. In the context of selling a business, arbitrage may involve identifying undervalued businesses or assets, acquiring them at a lower price, and then selling them at a higher price to realize a profit. This could involve various strategies such as purchasing distressed businesses, improving their operations or market positioning, and subsequently selling them at a higher valuation.
About Our Guest
Adam Coffey
Adam Coffey is a seasoned entrepreneur, acclaimed author, and innovative business leader with over two decades of experience. He has authored several influential books on entrepreneurship and leadership, including “Unlocking the Superpowers of Trust, Purpose, and Energy,” and “Leading from the Edge: The Unlikely Path to Success and Fulfillment.”
Throughout his career, Coffey has served as CEO for three prominent companies, including CoolSys, WASH Multifamily Laundry Systems, and Masterplan Business Advisory.