The largest private companies aren’t the most valuable private companies.
Forbes, Crain’s, and American City Business Journals all publish lists of the largest private companies. Forbes ranks them across the entire country and Crain’s and American City Business Journals rank them for every major city.
If you look at any of these lists, whether regional or national, you’ll notice a pattern. A lot of the companies are in low margin industries. According to Forbes, 6 of the 10 largest private companies in America are grocery chains or distributors, both of which are known for their razor-thin margins.
Forbes, Crain’s, and ACBJ rank companies by revenue since it’s the piece of data that’s most readily available. It’s hard to get private company information and more companies volunteer revenue metrics than profit metrics. If the publishers were somehow able to reshuffle their rankings to be based on profits, the order of logos would be different. But it wouldn’t be as different as you might think. Even on a hypothetical list of the private companies that generate the most profits, companies with lower margins would still be overrepresented.
Why is that?
It’s because low margin businesses, along with certain other types of businesses, have a large optimum firm size. Some companies need to be big to exist.
There are three reasons why this happens: advantages in capabilities, relationships, and costs.
Advantages in Capabilities: Some tasks are so huge that only a large company can undertake them. It’s why every region has its own set of major construction companies. If single family home renovations are the low stakes tables at a casino, multifamily construction projects are the high stakes tables. The pot sizes are huge for large projects and only the whales can play.
Advantages in Relationships: Another group of companies that are large by necessity are the local representatives of even larger companies. Dealerships and franchise groups are both good examples. Roughly 30 car brands comprise the majority of new vehicle sales in the U.S. Most brands sell through independently owned dealerships. Each dealership has the exclusive right to market a brand in a specific region. With such high-ticket inventory and so few brands in existence, even smaller dealerships tend to be pretty big businesses.
Advantages in Costs: The last group of companies that are large because they need to be is the most diverse: companies whose cost of delivering their product or service gets cheaper at scale. All distribution companies fall into this bucket. For example, consider a company that distributes snack foods to convenience stores. If they deliver products to stores located at 1 Main Street and 3 Main Street, they might as well also deliver products to 2 Main Street. It would be cheaper for them to do it than anyone else.
Published lists of the largest private companies are dominated by companies that must be large to exist, so it seems almost impossible to build a similarly sized company. The hill looks steep from the bottom. But the lists are misleading, both clerically and practically.
The clerical reason the lists give a false impression is that they’re samples and not populations. There are more large private companies than appear. Publishers only include companies that self-report revenues or are too conspicuous to miss. There are just as many middle market companies that simply don’t want to be found. Many of the ones that don’t want to be found, the “quiet giants,” are also the most interesting. You wouldn’t expect them to be as successful as they are.
Not only are the lists samples, but they’re also only samples of a specific point in time. Before today, many other similarly sized private companies existed that later sold or went public. Entrepreneurs built those businesses as well. They just made the choice to no longer remain independent.
This is one of the reasons why so few software companies appear. Most software companies that become large fuel their growth with venture capital dollars that later impel them to sell or go public. A snapshot would have to capture the fleeting window after they become large and before they are no longer private and independent. That’s usually a short period of time.
There is another, more actionable reason why large private companies don’t need to be as scarce as they are. Most companies only grow as fast as their owners want them to. And for individual owners, there is such a thing as “enough.”
Growth is a hassle. It means more HR problems. More time on the road. More cash reinvested for a new sales team instead of a new home.
Most private companies are sole proprietorships or partnerships whose owners size their appetites to their own needs. Earning $1 million a year is enough.
But for private equity firms, ownership is a profession. Private equity owners don’t size their ambitions to the limits of individual consumption. They size them according to their firm’s aspirations. Private equity firms want to return a multiple of their fund size and raise further, larger funds.
Some private equity firms do this by selling quickly and taking wins when they can. Others, like Majority Search, take a long-term mindset and aim to build and hold businesses forever.
The private equity industry is maturing and the mix of business ownership is shifting from individual to professional. Over time, the composition of the lists of the largest private companies will change as well. In the future, more of the largest private companies will be huge not because they need to be, but because their owners want them to be.