Private Equity Firm Got Rich Making Private Equity Firms Rich

A sneakily important fact of finance is that if you make $10 million a year, you make $10 million a year, but if you own a company that makes $10 million a year, it’s worth at least, say, $100 million. A stream of income is worth some multiple of a year’s income, depending on things like interest rates and how risky the income is and how much it is expected to grow; I am going to use a multiple of 10x for simplicity but real numbers will vary. (The price/earnings ratio of the S&P 500 index right now is about 29.6x; a company with that multiple and a $10 million annual net income would be worth $296 million.)

This means that if you are in some money-making business, it might be a good idea to sell a portion of your business. If you make $10 million a year, and the right multiple on your earnings is 10 times, then you own a $100 million business. If you sell 20% of that business to someone else, then that gets you several benefits: