From: alexhormozi
Investing in businesses, particularly through private equity, offers substantial wealth creation opportunities, often surpassing traditional real estate investments at the highest levels [00:00:00]. This approach focuses on accelerating business value by making strategic moves that reduce risk and increase profitability [00:13:00].
Real Estate vs. Business Investment
The majority of millionaires are made in real estate, while billionaires often find their fortunes in private equity [00:00:00].
Real Estate Model
In real estate, money is typically made in two primary ways:
- Appreciation: The value of the property increases over time [00:25:00]. This can be natural appreciation or “forced appreciation” through improvements like renovations (e.g., adding a kitchen or cleaning windows) [00:48:00].
- Rental Income: Receiving consistent payments from tenants [00:32:00].
Real estate is considered a simpler business model [01:09:00]. As long as population growth continues, real estate is generally a good investment [01:32:00]. However, there’s an upside limit; 100x returns are unlikely [04:10:00]. A significant risk is population decline, as seen in Japan’s real estate market [01:37:00].
Private Equity / Business Investment
Private equity offers more diverse ways to make money and allows for a much wider range of acquisition prices, with some businesses even being acquired for free, especially if they have no debt [02:08:00]. Businesses can accelerate in value dramatically; a business can go from not valuable to hundreds of millions of dollars in 12 months, especially with technology or patents [02:46:00].
A key strategy in private equity is to identify negatives or risks associated with a business and then transform them into “pillars of value” [03:39:00]. This effectively counts twice, removing a negative discount and adding to the business’s multiple [03:48:00]. Unlike real estate, you can fundamentally change a business’s “neighborhood” or category [04:00:00]. It’s possible to achieve 100x returns in private equity [04:14:00].
How Value is Created in Businesses
The valuation of a business is primarily determined by two variables:
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): Essentially, the company’s profit before certain accounting and financial deductions [09:00:00].
- Multiple: A multiplier applied to the EBITDA to determine the business’s overall value [09:17:00].
The multiple ascribed to a business’s profits is directly correlated to the risk associated with it, or rather, how likely it is to continue making money reliably [06:17:00].
Case Study: Small vs. Valuable Business
Consider two businesses:
- Business A: 1 million in profit. Has keyman risk (founder integrally involved), few employees, volatile, and screams risk [04:36:00]. It’s likely unsellable to an external buyer, although the owner derives value from it [11:03:00].
- Business B: Starts similar, but with a few strategic moves (e.g., hiring a CEO/COO, updating sales/marketing, optimizing pricing), it reaches 5 million in profit in 12-24 months [05:26:00]. If it gets an 8x multiple, it becomes a $40 million business [08:09:00].
This demonstrates the arbitrage in private equity, where huge step-ups in value can be created with relatively small changes and time [08:30:00].
Three Ways to Increase Business Value
Fundamentally, there are three ways to make a business more valuable [14:01:00]:
- Increase Customers: Grow the customer base [14:06:00].
- Increase Customer Value (LTV/LGP): Make existing customers worth more over time [14:10:00].
- Decrease Risk / Increase Reliability: Make the business’s future earnings more predictable and secure [14:19:00].
Every allocation of time or money in a business should clearly contribute to one of these three objectives [14:31:00].
Key Levers for Increasing Business Value
Experienced private equity investors use specific levers to increase the multiple and, therefore, the value of a business.
A. Debt Carrying Capacity
The amount of debt a business can support is a function of its cash flow [15:50:00]. Businesses with high, reliable cash flow can take on significantly more debt, which amplifies returns for investors through leverage [15:53:00].
B. Organic Growth
Consistent organic growth (through marketing, sales, and pricing strategies) significantly increases a business’s multiple [16:28:00]. If a business can reliably grow 20% year-over-year, it can more than double in five years, leading to substantial returns for investors due to debt leverage [16:48:00]. This is a core component of investment and company growth strategies.
C. Categorization
Reclassifying a business type can dramatically increase its multiple [17:13:00]. For example, transitioning a traditional service business into a “Tech-enabled service” or even a “SaaS” (Software as a Service) business by integrating technology can lead to significantly higher multiples [17:23:00]. An investment of 3 million to the enterprise value, representing a 30x return on that specific investment [17:55:00].
D. Size Premiums
Contrary to wholesale buying where bulk is cheaper, businesses gain a “size premium” when they reach a certain scale [18:48:00]. A business doing 100,000 [18:55:00]. Institutional investors like BlackRock and Blackstone have minimum check sizes (e.g., 5 million in annual profit [20:16:00]. Crossing the $10 million profit mark further enhances the multiple, creating a double multiplier effect [20:30:00]. This illustrates a key aspect of investment and financial advice for business growth.
E. Age (Patience)
The age of a business also contributes to its value [21:16:00]. An older, more established business (e.g., 10 years old) doing the same numbers as a younger one (e.g., 1 year old) is generally perceived as less risky and more reliable, thus commanding a higher valuation [21:21:00]. A business becomes more valuable every year it continues to grow or even maintain its position, until it declines, at which point its value can plummet [21:34:00]. This highlights the importance of sustained business growth strategies.
Importance of Focus and Long-Term Commitment
Many people fail to get rich because they don’t understand where value is created and fail to focus their efforts effectively [14:55:00]. Constantly switching between “opportunity vehicles” or starting new side hustles every six months prevents compounding value [23:31:00].
Diversifying too early by jumping to new opportunities means missing out on the compounding growth and increasing multiples that come with sticking with a single business over time [23:58:00]. A mediocre opportunity executed consistently for a long period (e.g., 50 years) will yield far greater returns than constantly switching to seemingly superior, but inconsistently pursued, opportunities [24:39:00]. This long-term focus is crucial for building a valuable business and achieving generational wealth [25:11:00].
Most of the value creation levers in private equity (like categorization, size premiums, and age) take time and consistent effort to implement [24:53:00]. This is not a “get rich in six weeks” scheme, but rather a “get rich in six years” approach, which is considered a relatively short timeframe for such substantial returns [22:42:00].