The Music Has Stopped

For two decades, private equity has operated on a simple premise: buy a company at 6x EBITDA, hold it for five years, and sell it at 8x. When that stopped working, they bought at 8x and sold at 10x. Then 10x to 12x. By 2021, firms were paying 15x for businesses that a decade earlier would have traded at 5x.

This wasn't value creation—it was value transfer. A sophisticated game of musical chairs where each buyer justified higher prices by pointing to the last transaction. The $3.6 trillion in trapped portfolio companies isn't just illiquid inventory. It's the moment the music stopped, and 30,000 companies are left standing without a chair.

The uncomfortable truth: Without perpetual multiple expansion, much of PE's historical returns disappear. Strip away the leverage and the fee engineering, and you're left with businesses growing at GDP plus inflation.

The Illiquidity Challenge

The valuation challenge facing PE isn't unique to private markets—both public and private valuations expanded significantly over the past two decades. The difference is what happens when conditions change.

Sources: Mid-market PE multiples from PitchBook and Bain & Company Global Private Equity Reports (2019-2025). S&P 500 P/E ratios from Robert Shiller data. Mid-market defined as buyouts under $1 billion in enterprise value.

Mid-market PE multiples grew from 8.2x in 2005 to 13.8x in 2019. The S&P 500 P/E ratio expanded from 20.0x to 36.0x over the same period. Both markets participated in significant multiple expansion.

The critical difference: Public market investors can still sell at current multiples. Mid-market PE firms face a different reality. According to Bain's 2025 Global Private Equity Report, PE firms are holding nearly 30,000 unsold companies worth $3.6 trillion. PitchBook data shows exit values dropped 19% quarter-on-quarter in Q1 2025, with exit count falling 25.2%.

This is an illiquidity problem. When valuations expanded, PE firms acquired businesses assuming they could exit at similar or higher multiples. That assumption no longer holds, leaving thousands of portfolio companies in a holding pattern.

The Great Multiple Fiction

The premise of modern private equity has been value creation through operational improvement. But there's a gap between premise and practice: buying a plumbing business at 5x and selling it at 10x isn't value creation if the plumber still fixes the same number of toilets the same way. It's multiple arbitrage—hoping the next buyer will pay more for the same cash flows.

This worked when rates were zero and capital was desperate for yield. But at 5% risk-free rates, the calculus has changed fundamentally.

The 30,000 companies currently in portfolios tell the story. Many are sitting at 2021 valuations that no buyer will pay. McKinsey consultants were brought in to recommend "digital transformation," but often the HVAC company still dispatches trucks the same way, the medical practice still schedules appointments manually, the manufacturer still manages inventory on spreadsheets.

The operational improvements that were promised didn't always materialize in ways that justified the entry multiples.

Real Transformation vs. Financial Engineering

This is where challenge becomes opportunity. What if the industry moved beyond financial engineering and delivered actual operational transformation?

Here's what that looks like: That plumbing business still fixes pipes, but now their scheduling runs itself, their inventory predicts what parts they'll need next month, their invoicing happens automatically, and their customer data tells them which neighborhoods will need repiping in the next five years. The plumber still plumbs—but everything else that ate up 60% of their day is automated. Their margins go from 20% to 40%. Their revenue per employee doubles.

This isn't financial engineering. It's giving a services business the operational leverage of a software company. When you can handle twice the revenue with the same headcount, when your back office runs itself, when every customer interaction feeds an intelligence system—that's when a plumbing business actually deserves a 10x multiple. Because now it's not a plumbing business anymore. It's a tech-enabled platform that happens to fix pipes.

The Path Forward

The firms sitting on $1 trillion in dry powder face a choice: continue the old playbook or fundamentally change their approach. The continuation funds, the NAV loans, the secondaries market—these are tools to manage the transition, but they're not solutions to the underlying challenge.

As John Romeo, managing partner at Oliver Wyman, recently noted: "They just paid too much, so they're not going to make the target returns on those, and that's blocked up the system."

The opportunity lies in doing what PE has always aspired to do but rarely achieved at scale: genuine operational transformation. Not org charts and KPIs, but fundamental reimagination of how work gets done. The healthcare staffing firm where AI matches nurses to shifts in seconds. The logistics company where routes optimize themselves. The manufacturer where inventory, production, and shipping operate as one intelligent system.

This represents the greatest arbitrage opportunity in PE history: buying traditional businesses at traditional multiples and transforming them into something that genuinely deserves premium valuations. Not through multiple expansion assumptions, but through making these businesses operate in fundamentally different ways.

Some firms will continue the traditional approach, working through their existing portfolios. Others will pioneer a new model—combining the discipline and downside protection of private equity with transformation capabilities that create real operational leverage.

Higher Order Capital represents this second path. We're not waiting for market conditions to improve. We're buying and building businesses that deserve their valuations through fundamental transformation—giving traditional companies the operational characteristics of technology businesses.

The market has reset. The question is who adapts.