Early history of private equity
Encyclopedia
The early history of private equity relates to one of the major periods in the history of private equity and venture capital
. Within the broader private equity
industry, two distinct sub-industries, leveraged buyouts and venture capital
experienced growth along parallel although interrelated tracks.
The origins of the modern private equity industry trace back to 1946 with the formation of the first venture capital firms. The thirty-five year period from 1946 through the end of the 1970s was characterized by relatively small volumes of private equity investment, rudimentary firm organizations and limited awareness of and familiarity with the private equity industry.
Investors have been acquiring businesses and making minority investments in privately held companies since the dawn of the industrial revolution. Merchant bankers in London and Paris financed industrial concerns in the 1850s; most notably Credit Mobilier
, founded in 1854 by Jacob and Isaac Pereire, who together with New York based Jay Cooke
financed the United States Transcontinental Railroad
.
Later, J. Pierpont Morgan's J.P. Morgan & Co.
would finance railroads and other industrial companies throughout the United States. In certain respects, J. Pierpont Morgan's 1901 acquisition of Carnegie Steel Company
from Andrew Carnegie
and Henry Phipps
for $480 million represents the first true major buyout as they are thought of today.
Due to structural restrictions imposed on American banks under the Glass–Steagall Act and other regulations in the 1930s, there was no private merchant bank
ing industry in the United States, a situation that was quite exceptional in developed nations. As late as the 1980s, Lester Thurow
, a noted economist
, decried the inability of the financial regulation framework in the United States to support merchant banks. US investment banks were confined primarily to advisory businesses, handling mergers and acquisitions
transactions and placements of equity and debt securities. Investment banks would later enter the space, however long after independent firms had become well established.
With few exceptions, private equity in the first half of the 20th century was the domain of wealthy individuals and families. The Vanderbilts, Whitneys, Rockefellers and Warburgs were notable investors in private companies in the first half of the century. In 1938, Laurance S. Rockefeller helped finance the creation of both Eastern Air Lines and Douglas Aircraft and the Rockefeller family had vast holdings in a variety of companies. Eric M. Warburg
founded E.M. Warburg & Co. in 1938, which would ultimately become Warburg Pincus
, with investments in both leveraged buyouts and venture capital.
that what is considered today to be true private equity investments began to emerge marked by the founding of the first two venture capital firms in 1946: American Research and Development Corporation
. (ARDC) and J.H. Whitney & Company
.
ARDC was founded by Georges Doriot
, the "father of venture capitalism" (former dean of Harvard Business School
), with Ralph Flanders
and Karl Compton (former president of MIT), to encourage private sector investments in businesses run by soldiers who were returning from World War II. ARDC's significance was primarily that it was the first institutional private equity investment firm that raised capital from sources other than wealthy families although it had several notable investment successes as well. ARDC is credited with the first major venture capital success story when its 1957 investment of $70,000 in Digital Equipment Corporation
(DEC) would be valued at over $355 million after the company's initial public offering in 1968 (representing a return of over 500 times on its investment and an annualized rate of return
of 101%). Former employees of ARDC went on to found several prominent venture capital firms including Greylock Partners (founded in 1965 by Charlie Waite and Bill Elfers) and Morgan, Holland Ventures, the predecessor of Flagship Ventures (founded in 1982 by James Morgan). ARDC
continued investing until 1971 with the retirement of Doriot. In 1972, Doriot merged ARDC with Textron
after having invested in over 150 companies.
J.H. Whitney & Company
was founded by John Hay Whitney
and his partner Benno Schmidt
. Whitney had been investing since the 1930s, founding Pioneer Pictures
in 1933 and acquiring a 15% interest in Technicolor Corporation with his cousin Cornelius Vanderbilt Whitney
. By far, Whitney's most famous investment was in Florida Foods Corporation. The company, having developed an innovative method for delivering nutrition to American soldiers, later came to be known as Minute Maid
orange juice and was sold to The Coca-Cola Company
in 1960. J.H. Whitney & Company
continues to make investments in leveraged buyout transactions and raised $750 million for its sixth institutional
private equity fund
in 2005.
Before World War II, venture capital investments (originally known as "development capital") were primarily the domain of wealthy individuals and families. One of the first steps toward a professionally-managed venture capital industry was the passage of the Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S. Small Business Administration
(SBA) to license private "Small Business Investment Companies" (SBICs) to help the financing and management of the small entrepreneurial businesses in the United States. Passage of the Act addressed concerns raised in a Federal Reserve Board report to Congress that concluded that a major gap existed in the capital markets for long-term funding for growth-oriented small businesses. Additionally, it was thought that fostering entrepreneurial companies would spur technological advances to compete against the Soviet Union
. Facilitating the flow of capital through the economy up to the pioneering small concerns in order to stimulate the U.S. economy was and still is the main goal of the SBIC program today. The 1958 Act provided venture capital firms structured either as SBICs or Minority Enterprise Small Business Investment Companies (MESBICs) access to federal funds which could be leveraged at a ratio of up to 4:1 against privately raised investment funds. The success of the Small Business Administration's efforts are viewed primarily in terms of the pool of professional private equity investors that the program developed as the rigid regulatory limitations imposed by the program minimized the role of SBICs. In 2005, the SBA significantly reduced its SBIC program, though SBICs continue to make private equity investments.
During the 1960s and 1970s, venture capital firms focused their investment activity primarily on starting and expanding companies. More often than not, these companies were exploiting breakthroughs in electronic, medical or data-processing technology. As a result, venture capital came to be almost synonymous with technology finance.
It is commonly noted that the first venture-backed startup was Fairchild Semiconductor
(which produced the first commercially practicable integrated circuit), funded in 1959 by what would later become Venrock Associates
. Venrock was founded in 1969 by Laurance S. Rockefeller, the fourth of John D. Rockefeller's
six children as a way to allow other Rockefeller children to develop exposure to venture capital investments.
It was also in the 1960s that the common form of private equity fund
, still in use today, emerged. Private equity firms organized limited partnership
s to hold investments in which the investment professionals served as general partner
and the investors, who were passive limited partners, put up the capital. The compensation structure, still in use today, also emerged with limited partners paying an annual management fee of 1-2% and a carried interest
typically representing up to 20% of the profits of the partnership.
An early West Coast venture capital company was Draper and Johnson Investment Company, formed in 1962 by William Henry Draper III
and Franklin P. Johnson, Jr. In 1964 Bill Draper and Paul Wythes founded Sutter Hill Ventures
, and Pitch Johnson formed Asset Management Company.
The growth of the venture capital industry was fueled by the emergence of the independent investment firms on Sand Hill Road
, beginning with Kleiner, Perkins, Caufield & Byers
and Sequoia Capital
in 1972. Located, in Menlo Park, CA, Kleiner Perkins, Sequoia and later venture capital firms would have access to the burgeoning technology industries in the area. By the early 1970s, there were many semiconductor
companies based in the Santa Clara Valley
as well as early computer
firms using their devices and programming and service companies. Throughout the 1970s, a group of private equity firms, focused primarily on venture capital investments, would be founded that would become the model for later leveraged buyout and venture capital investment firms. In 1973, with the number of new venture capital firms increasing, leading venture capitalists formed the National Venture Capital Association
(NVCA). The NVCA was to serve as the industry trade group
for the venture capital industry. Venture capital firms suffered a temporary downturn in 1974, when the stock market crashed and investors were naturally wary of this new kind of investment fund. It was not until 1978 that venture capital experienced its first major fundraising year, as the industry raised approximately $750 million. During this period, the number of venture firms also increased. Among the firms founded in this period, in addition to Kleiner Perkins and Sequoia, that continue to invest actively are:
Venture capital played an instrumental role in developing many of the major technology companies of the 1980s. Some of the most notable venture capital investments were made in firms that include:
in May 1955. Under the terms of the transactions, McLean borrowed $42 million and raised an additional $7 million through an issue of preferred stock
. When the deal closed, $20 million of Waterman cash and assets were used to retire $20 million of the loan debt. The newly elected board
of Waterman then voted to pay an immediate dividend
of $25 million to McLean Industries.
Similar to the approach employed in the McLean transaction, the use of publicly traded holding companies as investment vehicles to acquire portfolios of investments in corporate assets would become a new trend in the 1960s popularized by the likes of Warren Buffett
(Berkshire Hathaway
) and Victor Posner
(DWG Corporation) and later adopted by Nelson Peltz
(Triarc), Saul Steinberg
(Reliance Insurance) and Gerry Schwartz
(Onex Corporation). These investment vehicles would utilize a number of the same tactics and target the same type of companies as more traditional leveraged buyouts and in many ways could be considered a forerunner of the later private equity firms. In fact, it is Posner who is often credited with coining the term "leveraged buyout" or "LBO"
Posner, who had made a fortune in real estate investments in the 1930s and 1940s acquired a major stake in DWG Corporation in 1966. Having gained control of the company, he used it as an investment vehicle that could execute takeover
s of other companies. Posner and DWG are perhaps best known for the hostile takeover
of Sharon Steel Corporation
in 1969, one of the earliest such takeovers in the United States. Posner's investments were typically motivated by attractive valuations, balance sheets and cash flow characteristics. Because of its high debt load, Posner's DWG would generate attractive but highly volatile returns and would ultimately land the company in financial difficulty. In 1987, Sharon Steel sought Chapter 11
bankruptcy protection.
Warren Buffett
, who is typically described as a stock market
investor rather than a private equity investor, employed many of the same techniques in the creation on his Berkshire Hathaway conglomerate as Posner's DWG Corporation and in later years by more traditional private equity investors. In 1965, with the support of the company's board of directors
, Buffett assumed control of Berkshire Hathaway. At the time of Buffett's investment, Berkshire Hathaway was a textile company, however, Buffett used Berkshire Hathaway as an investment vehicle to make acquisitions and minority investments in dozens of the insurance
and reinsurance
industries (GEICO
) and varied companies including: American Express
, The Buffalo News
, the Coca-Cola Company
, Fruit of the Loom
, Nebraska Furniture Mart
and See's Candies
. Buffett's value investing
approach and focus on earnings and cash flows are characteristic of later private equity investors. Buffett would distinguish himself relative to more traditional leveraged buyout practitioners through his reluctance to use leverage
and hostile techniques in his investments.
and later his protégé, Henry Kravis
. Working for Bear Stearns
at the time, Kohlberg and Kravis along with Kravis' cousin George Roberts
began a series of what they described as "bootstrap" investments. They targeted family-owned businesses, many of which had been founded in the years following World War II
and by the 1960s and 1970s were facing succession issues. Many of these companies lacked a viable or attractive exit for their founders as they were too small to be taken public and the founders were reluctant to sell out to competitors, making a sale to a financial buyer
potentially attractive. Their acquisition of Orkin Exterminating Company
in 1964 is among the first significant leveraged buyout transactions. In the following years, the three Bear Stearns bankers would complete a series of buyouts including Stern Metals (1965), Incom (a division of Rockwood International, 1971), Cobblers Industries (1971) and Boren Clay (1973) as well as Thompson Wire, Eagle Motors and Barrows through their investment in Stern Metals. Although they had a number of highly successful investments, the $27 million investment in Cobblers ended in bankruptcy.
By 1976, tensions had built up between Bear Stearns and Kohlberg, Kravis and Roberts leading to their departure and the formation of Kohlberg Kravis Roberts in that year. Most notably, Bear Stearns executive Cy Lewis had rejected repeated proposals to form a dedicated investment fund within Bear Stearns and Lewis took exception to the amount of time spent on outside activities. Early investors included the Hillman Family By 1978, with the revision of the ERISA regulations, the nascent KKR was successful in raising its first institutional fund with approximately $30 million of investor commitments.
Meanwhile in 1974, Thomas H. Lee
founded a new investment firm to focus on acquiring companies through leveraged buyout transactions, one of the earliest independent private equity firms to focus on leveraged buyouts of more mature companies rather than venture capital investments in growth companies. Lee's firm, Thomas H. Lee Partners
, while initially generating less fanfare than other entrants in the 1980s, would emerge as one of the largest private equity firms globally by the end of the 1990s.
The second half of the 1970s and the first years of the 1980s saw the emergence of several private equity firms that would be survive through the various cycles both in leveraged buyouts and venture capital. Among the firms founded during these years were:
Management buyouts also came into existence in the late 1970s and early 1980s. One of the most notable early management buyout transactions was the acquisition of Harley-Davidson
. A group of managers at Harley-Davidson, the motorcycle manufacturer, bought the company from AMF in a leveraged buyout in 1981, but racked up big losses the following year and had to ask for protection from Japanese competitors.
In the years that would follow these events, private equity would experience its first major boom, acquiring some of the famed brands and major industrial powers of American business.
, which would reign as the largest leveraged buyout transaction for nearly 17 years. In 1980, the private equity industry would raise approximately $2.4 billion of annual investor commitments and by the end of the decade in 1989 that figure stood at $21.9 billion marking the tremendous growth experienced.
History of private equity and venture capital
The history of private equity and venture capital and the development of these asset classes has occurred through a series of boom and bust cycles since the middle of the 20th century. Within the broader private equity industry, two distinct sub-industries, leveraged buyouts and venture capital...
. Within the broader private equity
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
industry, two distinct sub-industries, leveraged buyouts and venture capital
Venture capital
Venture capital is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as...
experienced growth along parallel although interrelated tracks.
The origins of the modern private equity industry trace back to 1946 with the formation of the first venture capital firms. The thirty-five year period from 1946 through the end of the 1970s was characterized by relatively small volumes of private equity investment, rudimentary firm organizations and limited awareness of and familiarity with the private equity industry.
Pre-history
Credit Mobilier
Credit Mobilier may refer to:* Crédit Mobilier, a large French bank* Crédit Mobilier of America, an American railroad construction company setup by the Union Pacific Railroad to build the First Transcontinental Railroad in the 1860s *...
, founded in 1854 by Jacob and Isaac Pereire, who together with New York based Jay Cooke
Jay Cooke
Jay Cooke was an American financier. Cooke and his firm Jay Cooke & Company were most notable for their role in financing the Union's war effort during the American Civil War...
financed the United States Transcontinental Railroad
Transcontinental railroad
A transcontinental railroad is a contiguous network of railroad trackage that crosses a continental land mass with terminals at different oceans or continental borders. Such networks can be via the tracks of either a single railroad, or over those owned or controlled by multiple railway companies...
.
J.P. Morgan & Co.
J.P. Morgan & Co. was a commercial and investment banking institution based in the United States founded by J. Pierpont Morgan and commonly known as the House of Morgan or simply Morgan. Today, J.P...
would finance railroads and other industrial companies throughout the United States. In certain respects, J. Pierpont Morgan's 1901 acquisition of Carnegie Steel Company
Carnegie Steel Company
Carnegie Steel Company was a steel producing company created by Andrew Carnegie to manage business at his steel mills in the Pittsburgh, Pennsylvania area in the late 19th century.-Creation:...
from Andrew Carnegie
Andrew Carnegie
Andrew Carnegie was a Scottish-American industrialist, businessman, and entrepreneur who led the enormous expansion of the American steel industry in the late 19th century...
and Henry Phipps
Henry Phipps
Henry Phipps, Jr. was an American entrepreneur and major philanthropist.-Biography:He was the son of an English shoemaker who emigrated in the early part of the 19th century to Philadelphia, Pennsylvania before settling in Pittsburgh. When a child, he was a friend and neighbor to Andrew Carnegie...
for $480 million represents the first true major buyout as they are thought of today.
Due to structural restrictions imposed on American banks under the Glass–Steagall Act and other regulations in the 1930s, there was no private merchant bank
Merchant bank
A merchant bank is a financial institution which provides capital to companies in the form of share ownership instead of loans. A merchant bank also provides advisory on corporate matters to the firms they lend to....
ing industry in the United States, a situation that was quite exceptional in developed nations. As late as the 1980s, Lester Thurow
Lester Thurow
Lester Carl Thurow is a former dean of the MIT Sloan School of Management and author of books on economic topics. Thurow was born in Livingston, Montana.-Education:...
, a noted economist
Economist
An economist is a professional in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
, decried the inability of the financial regulation framework in the United States to support merchant banks. US investment banks were confined primarily to advisory businesses, handling mergers and acquisitions
Mergers and acquisitions
Mergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or...
transactions and placements of equity and debt securities. Investment banks would later enter the space, however long after independent firms had become well established.
With few exceptions, private equity in the first half of the 20th century was the domain of wealthy individuals and families. The Vanderbilts, Whitneys, Rockefellers and Warburgs were notable investors in private companies in the first half of the century. In 1938, Laurance S. Rockefeller helped finance the creation of both Eastern Air Lines and Douglas Aircraft and the Rockefeller family had vast holdings in a variety of companies. Eric M. Warburg
Eric M. Warburg
Eric M. Warburg was a member of the prominent Warburg family of German-Jewish bankers. Although he was the founder of the small New York firm that later became Warburg Pincus, and a partner in M.M.Warburg & CO he is most known for his efforts to strengthen German-American relations, for which he...
founded E.M. Warburg & Co. in 1938, which would ultimately become Warburg Pincus
Warburg Pincus
Warburg Pincus, LLC is an American private equity firm with offices in the United States, Europe, Brazil and Asia. It has been a private equity investor since 1966...
, with investments in both leveraged buyouts and venture capital.
Origins of modern private equity
It was not until after World War IIWorld War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
that what is considered today to be true private equity investments began to emerge marked by the founding of the first two venture capital firms in 1946: American Research and Development Corporation
American Research and Development Corporation
American Research and Development Corporation was a venture capital and private equity firm founded in 1946 by Georges Doriot, the "father of venture capitalism" , with Ralph Flanders and Karl Compton .ARDC is credited with the first major venture capital success story when its 1957 investment of...
. (ARDC) and J.H. Whitney & Company
J.H. Whitney & Company
J.H. Whitney & Company is a venture capital firm in the U.S., founded in 1946 by John Hay Whitney and his partner Benno Schmidt. Today the firm focuses primarily on leveraged buyouts, turnarounds, acquisitions, and recapitalizations of more mature companies particularly those it considers to be in...
.
ARDC was founded by Georges Doriot
Georges Doriot
Georges F. Doriot was one of the first American venture capitalists. In 1946, he founded American Research and Development Corporation, the first publicly owned venture capital firm...
, the "father of venture capitalism" (former dean of Harvard Business School
Harvard Business School
Harvard Business School is the graduate business school of Harvard University in Boston, Massachusetts, United States and is widely recognized as one of the top business schools in the world. The school offers the world's largest full-time MBA program, doctoral programs, and many executive...
), with Ralph Flanders
Ralph Flanders
Ralph Edward Flanders was an American mechanical engineer, industrialist and Republican U.S. Senator from the state of Vermont. He grew up on subsistence farms in Vermont and Rhode Island, became an apprentice first as a machinist, then as a draftsman, before training as a mechanical engineer...
and Karl Compton (former president of MIT), to encourage private sector investments in businesses run by soldiers who were returning from World War II. ARDC's significance was primarily that it was the first institutional private equity investment firm that raised capital from sources other than wealthy families although it had several notable investment successes as well. ARDC is credited with the first major venture capital success story when its 1957 investment of $70,000 in Digital Equipment Corporation
Digital Equipment Corporation
Digital Equipment Corporation was a major American company in the computer industry and a leading vendor of computer systems, software and peripherals from the 1960s to the 1990s...
(DEC) would be valued at over $355 million after the company's initial public offering in 1968 (representing a return of over 500 times on its investment and an annualized rate of return
Internal rate of return
The internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...
of 101%). Former employees of ARDC went on to found several prominent venture capital firms including Greylock Partners (founded in 1965 by Charlie Waite and Bill Elfers) and Morgan, Holland Ventures, the predecessor of Flagship Ventures (founded in 1982 by James Morgan). ARDC
American Research and Development Corporation
American Research and Development Corporation was a venture capital and private equity firm founded in 1946 by Georges Doriot, the "father of venture capitalism" , with Ralph Flanders and Karl Compton .ARDC is credited with the first major venture capital success story when its 1957 investment of...
continued investing until 1971 with the retirement of Doriot. In 1972, Doriot merged ARDC with Textron
Textron
Textron is a conglomerate that includes Bell Helicopter, E-Z-GO, Cessna Aircraft Company, and Greenlee, among others. It was founded by Royal Little in 1923 as the Special Yarns Company, and is headquartered at the Textron Tower in Providence, Rhode Island, United States.With total revenues of...
after having invested in over 150 companies.
J.H. Whitney & Company
J.H. Whitney & Company
J.H. Whitney & Company is a venture capital firm in the U.S., founded in 1946 by John Hay Whitney and his partner Benno Schmidt. Today the firm focuses primarily on leveraged buyouts, turnarounds, acquisitions, and recapitalizations of more mature companies particularly those it considers to be in...
was founded by John Hay Whitney
John Hay Whitney
John Hay Whitney , colloquially known as "Jock" Whitney, was U.S. Ambassador to the United Kingdom, publisher of the New York Herald Tribune, and a member of the Whitney family.-Family:...
and his partner Benno Schmidt
Benno C. Schmidt, Sr.
Benno Charles Schmidt, Sr. was an American lawyer and venture capitalist who was active in New York City civic affairs and played an important role in the initiation of the War on Cancer....
. Whitney had been investing since the 1930s, founding Pioneer Pictures
Pioneer Pictures
Pioneer Pictures, Inc. was a Hollywood motion picture company, most noted for its early commitment to making color films. Pioneer was initially affiliated with RKO Pictures, whose production facilities in Culver City, California were used by Pioneer, and who distributed Pioneer's films...
in 1933 and acquiring a 15% interest in Technicolor Corporation with his cousin Cornelius Vanderbilt Whitney
Cornelius Vanderbilt Whitney
Cornelius Vanderbilt Whitney was an American businessman, film producer, writer, and government official, as well as the owner of a leading stable of thoroughbred racehorses....
. By far, Whitney's most famous investment was in Florida Foods Corporation. The company, having developed an innovative method for delivering nutrition to American soldiers, later came to be known as Minute Maid
Minute Maid
Minute Maid is a product line of beverages, usually associated with lemonade or orange juice, but now extends to soft drinks of many kinds, including Hi-C...
orange juice and was sold to The Coca-Cola Company
The Coca-Cola Company
The Coca-Cola Company is an American multinational beverage corporation and manufacturer, retailer and marketer of non-alcoholic beverage concentrates and syrups. The company is best known for its flagship product Coca-Cola, invented in 1886 by pharmacist John Stith Pemberton in Columbus, Georgia...
in 1960. J.H. Whitney & Company
J.H. Whitney & Company
J.H. Whitney & Company is a venture capital firm in the U.S., founded in 1946 by John Hay Whitney and his partner Benno Schmidt. Today the firm focuses primarily on leveraged buyouts, turnarounds, acquisitions, and recapitalizations of more mature companies particularly those it considers to be in...
continues to make investments in leveraged buyout transactions and raised $750 million for its sixth institutional
Institutional investor
Institutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets...
private equity fund
Private equity fund
A private equity fund is a collective investment scheme used for making investments in various equity securities according to one of the investment strategies associated with private equity....
in 2005.
Before World War II, venture capital investments (originally known as "development capital") were primarily the domain of wealthy individuals and families. One of the first steps toward a professionally-managed venture capital industry was the passage of the Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S. Small Business Administration
Small Business Administration
The Small Business Administration is a United States government agency that provides support to entrepreneurs and small businesses. The mission of the Small Business Administration is "to maintain and strengthen the nation's economy by enabling the establishment and viability of small businesses...
(SBA) to license private "Small Business Investment Companies" (SBICs) to help the financing and management of the small entrepreneurial businesses in the United States. Passage of the Act addressed concerns raised in a Federal Reserve Board report to Congress that concluded that a major gap existed in the capital markets for long-term funding for growth-oriented small businesses. Additionally, it was thought that fostering entrepreneurial companies would spur technological advances to compete against the Soviet Union
Soviet Union
The Soviet Union , officially the Union of Soviet Socialist Republics , was a constitutionally socialist state that existed in Eurasia between 1922 and 1991....
. Facilitating the flow of capital through the economy up to the pioneering small concerns in order to stimulate the U.S. economy was and still is the main goal of the SBIC program today. The 1958 Act provided venture capital firms structured either as SBICs or Minority Enterprise Small Business Investment Companies (MESBICs) access to federal funds which could be leveraged at a ratio of up to 4:1 against privately raised investment funds. The success of the Small Business Administration's efforts are viewed primarily in terms of the pool of professional private equity investors that the program developed as the rigid regulatory limitations imposed by the program minimized the role of SBICs. In 2005, the SBA significantly reduced its SBIC program, though SBICs continue to make private equity investments.
Early venture capital and the growth of Silicon Valley (1959 - 1981)
It is commonly noted that the first venture-backed startup was Fairchild Semiconductor
Fairchild Semiconductor
Fairchild Semiconductor International, Inc. is an American semiconductor company based in San Jose, California. Founded in 1957, it was a pioneer in transistor and integrated circuit manufacturing...
(which produced the first commercially practicable integrated circuit), funded in 1959 by what would later become Venrock Associates
Venrock Associates
Venrock, a compound of "Venture" and "Rockefeller", is a pioneering venture capital firm formed in 1969 to build upon the successful investing activities of the Rockefeller family that began in the late 1930s. It has offices in Palo Alto, California, New York City, Cambridge, Massachusetts, and...
. Venrock was founded in 1969 by Laurance S. Rockefeller, the fourth of John D. Rockefeller's
John D. Rockefeller, Jr.
John Davison Rockefeller, Jr. was a major philanthropist and a pivotal member of the prominent Rockefeller family. He was the sole son among the five children of businessman and Standard Oil industrialist John D. Rockefeller and the father of the five famous Rockefeller brothers...
six children as a way to allow other Rockefeller children to develop exposure to venture capital investments.
It was also in the 1960s that the common form of private equity fund
Private equity fund
A private equity fund is a collective investment scheme used for making investments in various equity securities according to one of the investment strategies associated with private equity....
, still in use today, emerged. Private equity firms organized limited partnership
Limited partnership
A limited partnership is a form of partnership similar to a general partnership, except that in addition to one or more general partners , there are one or more limited partners . It is a partnership in which only one partner is required to be a general partner.The GPs are, in all major respects,...
s to hold investments in which the investment professionals served as general partner
General partner
General partner is a legal term used to describe a person who joins with at least one other person to form a business. A general partner has responsibility for the actions of the business, can legally bind the business and is personally liable for all the business's debts and obligations.General...
and the investors, who were passive limited partners, put up the capital. The compensation structure, still in use today, also emerged with limited partners paying an annual management fee of 1-2% and a carried interest
Carried interest
Carried interest or carry, in finance, specifically in alternative investment management, is a share of the profits of a successful investment partnership that is paid to the investment manager of the partnership as a form of compensation that is designed as an incentive to the manager to maximize...
typically representing up to 20% of the profits of the partnership.
An early West Coast venture capital company was Draper and Johnson Investment Company, formed in 1962 by William Henry Draper III
William Henry Draper III
William Henry Draper III is a prominent American venture capitalist.-Early life and career:Draper was born in White Plains, New York, the son of Katherine and banker and diplomat William Henry Draper, Jr. He attended Yale University with George H. W. Bush, graduated in 1950, the year after George...
and Franklin P. Johnson, Jr. In 1964 Bill Draper and Paul Wythes founded Sutter Hill Ventures
Sutter Hill Ventures
Sutter Hill Ventures is a private equity firm focused on venture capital investments in technology-based start-up companies. The firm is based in Palo Alto, CA....
, and Pitch Johnson formed Asset Management Company.
The growth of the venture capital industry was fueled by the emergence of the independent investment firms on Sand Hill Road
Sand Hill Road
Sand Hill Road is a road in Menlo Park, California, notable for its concentration of venture capital companies. Its significance as a symbol of private equity in the United States may be compared to that of Wall Street in the stock market...
, beginning with Kleiner, Perkins, Caufield & Byers
Kleiner, Perkins, Caufield & Byers
Kleiner Perkins Caufield & Byers ' is a world-leading venture capital firm located on Sand Hill Road in Menlo Park in Silicon Valley. The Wall Street Journal has called it one of the "largest and most established" venture capital firms in the world...
and Sequoia Capital
Sequoia Capital
Sequoia Capital is a Californian venture capital firm located on Sand Hill Road in Menlo Park, California. The Wall Street Journal has called Sequoia Capital "one of the highest-caliber venture firms", and noted that it is "one of Silicon Valley's most influential venture-capital firms"...
in 1972. Located, in Menlo Park, CA, Kleiner Perkins, Sequoia and later venture capital firms would have access to the burgeoning technology industries in the area. By the early 1970s, there were many semiconductor
Semiconductor
A semiconductor is a material with electrical conductivity due to electron flow intermediate in magnitude between that of a conductor and an insulator. This means a conductivity roughly in the range of 103 to 10−8 siemens per centimeter...
companies based in the Santa Clara Valley
Santa Clara Valley
The Santa Clara Valley is a valley just south of the San Francisco Bay in Northern California in the United States. Much of Santa Clara County and its county seat, San José, are in the Santa Clara Valley. The valley was originally known as the Valley of Heart’s Delight for its high concentration...
as well as early computer
Computer
A computer is a programmable machine designed to sequentially and automatically carry out a sequence of arithmetic or logical operations. The particular sequence of operations can be changed readily, allowing the computer to solve more than one kind of problem...
firms using their devices and programming and service companies. Throughout the 1970s, a group of private equity firms, focused primarily on venture capital investments, would be founded that would become the model for later leveraged buyout and venture capital investment firms. In 1973, with the number of new venture capital firms increasing, leading venture capitalists formed the National Venture Capital Association
National Venture Capital Association
The National Venture Capital Association is the leading trade association representing the venture capital industry in the U.S. The NVCA represents the venture industry in public policy debates in Washington, DC, and promotes high professional standards, professional development, and interaction...
(NVCA). The NVCA was to serve as the industry trade group
Industry trade group
A trade association, also known as an industry trade group, business association or sector association, is an organization founded and funded by businesses that operate in a specific industry...
for the venture capital industry. Venture capital firms suffered a temporary downturn in 1974, when the stock market crashed and investors were naturally wary of this new kind of investment fund. It was not until 1978 that venture capital experienced its first major fundraising year, as the industry raised approximately $750 million. During this period, the number of venture firms also increased. Among the firms founded in this period, in addition to Kleiner Perkins and Sequoia, that continue to invest actively are:
- TA AssociatesTA AssociatesTA Associates, founded in 1968, is one of the oldest private equity firms in the United States. The firm employs a hybrid strategy making growth capital investments in developing companies and acquiring mature companies through leveraged buyout and recapitalization transactions...
, a venture capital firm (and later leveraged buyouts as well), originally part of the Tucker AnthonyTucker AnthonyTucker Anthony was an independent investment banking and brokerage firm based in Boston, Massachusetts. In 2001, the firm was acquired by Royal Bank of Canada and was merged with the bank's Dain Rauscher Wessels subsidiary to create RBC Dain Rauscher....
brokerage firm, founded in 1968; - Mayfield FundMayfield FundMayfield Fund is one of the oldest venture capital firms in the US, focusing on early-stage to growth-stage investments in information technology companies with a focus on enterprise software, Internet consumer & media services, and communications....
, founded by early Silicon Valley venture capitalist Tommy DavisThomas J. Davis, Jr.Thomas Jefferson Davis, Jr. was an early Silicon Valley venture capitalist and founder of the Mayfield Fund.As Vice President of Kern County Land Company from 1957 to 1961, he managed its investment in four new companies including Watkins-Johnson Company, which investment of $900,000 was sold in...
in 1969; - Apax PartnersApax PartnersApax Partners LLP is a global private equity and venture capital firm, headquartered in London. The company also operates out of eight other offices in New York, Hong Kong, Mumbai, Tel-Aviv, Madrid, Stockholm, Milan and Munich. The firm, including its various predecessors, have raised...
, the firm's earliest predecessor, the venture capital firm Patricof & Co. was founded in 1969 and subsequently merged with Multinational Management Group (founded 1972) and later with Saunders Karp & Megrue (founded 1989); - Menlo VenturesMenlo VenturesMenlo Ventures is a venture capital firm located at 3000 Sand Hill Road in Menlo Park, California.The firm was founded as one of the earliest venture capital firms in Silicon Valley in 1976 and provides provides technology venture capital funding for seed, early stage and growth companies...
, co-founded by H.DuBose Montgomery in 1976; - New Enterprise AssociatesNew Enterprise AssociatesNew Enterprise Associates is a global investment firm focused on venture capital and growth equity investments. With approximately $11 billion in committed capital, NEA is among the largest venture firms. The firm invests in three broad industry sectors: information technology, healthcare, and...
founded by Chuck Newhall, Frank Bonsal and Dick Kramlich in 1978; - Oak Investment PartnersOak Investment PartnersOak Investment Partners is a private equity firm focusing on venture capital investments in companies developing communications systems, information technology, new Internet media, healthcare services and retail....
founded in 1978; and - Sevin Rosen FundsSevin Rosen FundsSevin Rosen Funds is a venture capital firm that was established in 1980 by L. J. Sevin and Ben Rosen. SRF was involved in the financing of Citrix, Cypress Semiconductor, Electronic Arts, Lotus Development Corporation, Silicon Graphics, and Vitesse Semiconductor...
founded by L.J. Sevin and Ben Rosen in 1980.
Venture capital played an instrumental role in developing many of the major technology companies of the 1980s. Some of the most notable venture capital investments were made in firms that include:
- Tandem ComputersTandem ComputersTandem Computers, Inc. was the dominant manufacturer of fault-tolerant computer systems for ATM networks, banks, stock exchanges, telephone switching centers, and other similar commercial transaction processing applications requiring maximum uptime and zero data loss. The company was founded in...
, an early manufacturer of computer systems, founded in 1975 by Jimmy TreybigJames TreybigJames Treybig founded Tandem Computers, a pioneering Silicon Valley manufacturer of fault tolerant computer systems which were marketed to the growing number of transaction processing customers who used them for ATMs, banks, stock exchanges and other similar needs.He attended Rice University,...
with funding from Kleiner, Perkins, Caufield & ByersKleiner, Perkins, Caufield & ByersKleiner Perkins Caufield & Byers ' is a world-leading venture capital firm located on Sand Hill Road in Menlo Park in Silicon Valley. The Wall Street Journal has called it one of the "largest and most established" venture capital firms in the world...
.
- GenentechGenentechGenentech Inc., or Genetic Engineering Technology, Inc., is a biotechnology corporation, founded in 1976 by venture capitalist Robert A. Swanson and biochemist Dr. Herbert Boyer. Trailing the founding of Cetus by five years, it was an important step in the evolution of the biotechnology industry...
a biotechnologyBiotechnologyBiotechnology is a field of applied biology that involves the use of living organisms and bioprocesses in engineering, technology, medicine and other fields requiring bioproducts. Biotechnology also utilizes these products for manufacturing purpose...
company, founded in 1976 with venture capital from Robert A. SwansonRobert A. SwansonRobert A. Swanson was a venture capitalist who cofounded the biotechnology giant Genentech in 1976 with Herbert Boyer. Genentech is a pioneer in the field, and it remains one of the leading biotech companies in the world....
.
- Apple Inc., a designer and manufacturer of consumer electronics, including the Macintosh computerMacintoshThe Macintosh , or Mac, is a series of several lines of personal computers designed, developed, and marketed by Apple Inc. The first Macintosh was introduced by Apple's then-chairman Steve Jobs on January 24, 1984; it was the first commercially successful personal computer to feature a mouse and a...
and in later years the iPodIPodiPod is a line of portable media players created and marketed by Apple Inc. The product line-up currently consists of the hard drive-based iPod Classic, the touchscreen iPod Touch, the compact iPod Nano, and the ultra-compact iPod Shuffle...
, founded in 1978. In December 1980, Apple went public. Its offering of 4.6 million shares at $22 each sold out within minutes. A second offering of 2.6 million shares quickly sold out in May 1981.
- Electronic ArtsElectronic ArtsElectronic Arts, Inc. is a major American developer, marketer, publisher and distributor of video games. Founded and incorporated on May 28, 1982 by Trip Hawkins, the company was a pioneer of the early home computer games industry and was notable for promoting the designers and programmers...
, a distributor of computer and video games found in May 1982 by Trip Hawkins with a personal investment of an estimated $200,000. Seven months later in December 1982, Hawkins secured $2 million of venture capital from Sequoia CapitalSequoia CapitalSequoia Capital is a Californian venture capital firm located on Sand Hill Road in Menlo Park, California. The Wall Street Journal has called Sequoia Capital "one of the highest-caliber venture firms", and noted that it is "one of Silicon Valley's most influential venture-capital firms"...
, Kleiner, PerkinsKleiner, Perkins, Caufield & ByersKleiner Perkins Caufield & Byers ' is a world-leading venture capital firm located on Sand Hill Road in Menlo Park in Silicon Valley. The Wall Street Journal has called it one of the "largest and most established" venture capital firms in the world...
and Sevin Rosen FundsSevin Rosen FundsSevin Rosen Funds is a venture capital firm that was established in 1980 by L. J. Sevin and Ben Rosen. SRF was involved in the financing of Citrix, Cypress Semiconductor, Electronic Arts, Lotus Development Corporation, Silicon Graphics, and Vitesse Semiconductor...
.
- CompaqCompaqCompaq Computer Corporation is a personal computer company founded in 1982. Once the largest supplier of personal computing systems in the world, Compaq existed as an independent corporation until 2002, when it was acquired for US$25 billion by Hewlett-Packard....
, 1982, Computer manufacturer. In 1982, venture capital firm Sevin Rosen FundsSevin Rosen FundsSevin Rosen Funds is a venture capital firm that was established in 1980 by L. J. Sevin and Ben Rosen. SRF was involved in the financing of Citrix, Cypress Semiconductor, Electronic Arts, Lotus Development Corporation, Silicon Graphics, and Vitesse Semiconductor...
provided $2.5 million to fund the startup of Compaq, which would ultimately grow into one of the largest personal computer manufacturers before merging with Hewlett Packard in 2002.
- Federal ExpressFedExFedEx Corporation , originally known as FDX Corporation, is a logistics services company, based in the United States with headquarters in Memphis, Tennessee...
, Venture capitalists invested $80 million to help founder Frederick W. SmithFrederick W. SmithFred Sidney Smith III , or Fred Smith, is the founder, chairman, president, and CEO of FedEx, originally known as Federal Express, the first overnight express delivery company in the world, and the largest in the United States...
purchase his first Dassault Falcon 20Dassault Falcon 20The Dassault Falcon 20 is a French business jet and was the first of a family of business jets built by Dassault Aviation.-Design and development:...
airplanes.
- LSI CorporationLSI CorporationLSI Corporation is an electronics company based in Milpitas, California that designs semiconductors and software that accelerate storage and networking in datacenters and mobile networks.-History:...
was funded in 1981 with $6 million from noted venture capitalists including Sequoia CapitalSequoia CapitalSequoia Capital is a Californian venture capital firm located on Sand Hill Road in Menlo Park, California. The Wall Street Journal has called Sequoia Capital "one of the highest-caliber venture firms", and noted that it is "one of Silicon Valley's most influential venture-capital firms"...
and Menlo VenturesMenlo VenturesMenlo Ventures is a venture capital firm located at 3000 Sand Hill Road in Menlo Park, California.The firm was founded as one of the earliest venture capital firms in Silicon Valley in 1976 and provides provides technology venture capital funding for seed, early stage and growth companies...
. A second round of financing for an additional $16 million was completed in March 1982. The firm went public on May 13, 1983, netting $153 million, the largest technology IPO to that point.
McLean Industries and public holding companies
Although not strictly private equity, and certainly not labeled so at the time, the first leveraged buyout may have been the purchase by Malcolm McLean's McLean Industries, Inc. of Pan-Atlantic Steamship Company in January 1955 and Waterman Steamship CorporationWaterman Steamship Corporation
Waterman Steamship Corporation is an American deep sea ocean carrier, specializing in liner services and time charter contracts. It is owned by International Shipholding Corporation, based in Mobile, Alabama....
in May 1955. Under the terms of the transactions, McLean borrowed $42 million and raised an additional $7 million through an issue of preferred stock
Preferred stock
Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...
. When the deal closed, $20 million of Waterman cash and assets were used to retire $20 million of the loan debt. The newly elected board
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
of Waterman then voted to pay an immediate dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
of $25 million to McLean Industries.
Similar to the approach employed in the McLean transaction, the use of publicly traded holding companies as investment vehicles to acquire portfolios of investments in corporate assets would become a new trend in the 1960s popularized by the likes of Warren Buffett
Warren Buffett
Warren Edward Buffett is an American business magnate, investor, and philanthropist. He is widely regarded as one of the most successful investors in the world. Often introduced as "legendary investor, Warren Buffett", he is the primary shareholder, chairman and CEO of Berkshire Hathaway. He is...
(Berkshire Hathaway
Berkshire Hathaway
Berkshire Hathaway Inc. is an American multinational conglomerate holding company headquartered in Omaha, Nebraska, United States, that oversees and manages a number of subsidiary companies. The company averaged an annual growth in book value of 20.3% to its shareholders for the last 44 years,...
) and Victor Posner
Victor Posner
Victor Posner was an American businessman. He was known as one of the highest paid business executives of his generation. He was a pioneer of the leveraged buyout.-Career:...
(DWG Corporation) and later adopted by Nelson Peltz
Nelson Peltz
Nelson Peltz is an American businessman. He is a board director of Wendy's Group, the franchise parent of T.J. Cinnamons, Pasta Connection and Wendy's. Peltz is the former owner of Snapple.- Background :...
(Triarc), Saul Steinberg
Saul Steinberg (business)
Saul Steinberg is a former financier, insurance executive, and corporate raider. He started a computer leasing company , which he used in an audacious and successful takeover of the much larger Reliance Insurance Company in 1968...
(Reliance Insurance) and Gerry Schwartz
Gerry Schwartz
Gerald W. Schwartz, OC born c.1941 in Winnipeg, Manitoba, is a Canadian businessman. In 1977 he co-founded CanWest Global Communications Inc, followed by Onex Corporation in 1983. He has been a director of Scotiabank since 1999...
(Onex Corporation). These investment vehicles would utilize a number of the same tactics and target the same type of companies as more traditional leveraged buyouts and in many ways could be considered a forerunner of the later private equity firms. In fact, it is Posner who is often credited with coining the term "leveraged buyout" or "LBO"
Posner, who had made a fortune in real estate investments in the 1930s and 1940s acquired a major stake in DWG Corporation in 1966. Having gained control of the company, he used it as an investment vehicle that could execute takeover
Takeover
In business, a takeover is the purchase of one company by another . In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company.- Friendly takeovers :Before a bidder makes an offer for another...
s of other companies. Posner and DWG are perhaps best known for the hostile takeover
Takeover
In business, a takeover is the purchase of one company by another . In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company.- Friendly takeovers :Before a bidder makes an offer for another...
of Sharon Steel Corporation
Sharon Steel Corporation
The Sharon Steel Corporation was once a steel plant, and is notable due to its contribution toward the growth of the iron and steel industry in the Shenango River Valley, Mercer County, Pennsylvania....
in 1969, one of the earliest such takeovers in the United States. Posner's investments were typically motivated by attractive valuations, balance sheets and cash flow characteristics. Because of its high debt load, Posner's DWG would generate attractive but highly volatile returns and would ultimately land the company in financial difficulty. In 1987, Sharon Steel sought Chapter 11
Chapter 11, Title 11, United States Code
Chapter 11 is a chapter of the United States Bankruptcy Code, which permits reorganization under the bankruptcy laws of the United States. Chapter 11 bankruptcy is available to every business, whether organized as a corporation or sole proprietorship, and to individuals, although it is most...
bankruptcy protection.
Warren Buffett
Warren Buffett
Warren Edward Buffett is an American business magnate, investor, and philanthropist. He is widely regarded as one of the most successful investors in the world. Often introduced as "legendary investor, Warren Buffett", he is the primary shareholder, chairman and CEO of Berkshire Hathaway. He is...
, who is typically described as a stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...
investor rather than a private equity investor, employed many of the same techniques in the creation on his Berkshire Hathaway conglomerate as Posner's DWG Corporation and in later years by more traditional private equity investors. In 1965, with the support of the company's board of directors
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
, Buffett assumed control of Berkshire Hathaway. At the time of Buffett's investment, Berkshire Hathaway was a textile company, however, Buffett used Berkshire Hathaway as an investment vehicle to make acquisitions and minority investments in dozens of the insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
and reinsurance
Reinsurance
Reinsurance is insurance that is purchased by an insurance company from another insurance company as a means of risk management...
industries (GEICO
GEICO
The Government Employees Insurance Company is an auto insurance company. It is a wholly owned subsidiary of Berkshire Hathaway that as of 2007 provided coverage for more than 10 million motor vehicles owned by more than 9 million policy holders. GEICO writes private passenger automobile insurance...
) and varied companies including: American Express
American Express
American Express Company or AmEx, is an American multinational financial services corporation headquartered in Three World Financial Center, Manhattan, New York City, New York, United States. Founded in 1850, it is one of the 30 components of the Dow Jones Industrial Average. The company is best...
, The Buffalo News
The Buffalo News
The Buffalo News is the primary newspaper of the Buffalo – Niagara Falls metropolitan area, and the area's only daily newspaper. It is the only newspaper owned by Berkshire Hathaway.-History:...
, the Coca-Cola Company
The Coca-Cola Company
The Coca-Cola Company is an American multinational beverage corporation and manufacturer, retailer and marketer of non-alcoholic beverage concentrates and syrups. The company is best known for its flagship product Coca-Cola, invented in 1886 by pharmacist John Stith Pemberton in Columbus, Georgia...
, Fruit of the Loom
Fruit of the Loom
Fruit of the Loom is an American company which manufactures clothing, particularly underwear. The company's world headquarters is in Bowling Green, Kentucky. It is currently a subsidiary of Berkshire Hathaway.-Company profile:...
, Nebraska Furniture Mart
Nebraska Furniture Mart
Nebraska Furniture Mart is the largest home furnishing store in North America selling Furniture, Flooring, Appliances and Electronics. NFM was founded in 1937 by Mrs. B in Omaha, Nebraska. She worked in the business until age 103. In 1983, Mrs. B sold a majority interest to Berkshire Hathaway with...
and See's Candies
See's Candies
See's Candies is a manufacturer and distributor of candy, particularly chocolate, in the western United States. It was founded by Charles See, his wife Florence, and his mother Mary in Los Angeles, California, in 1921. The company is now headquartered in South San Francisco, California...
. Buffett's value investing
Value investing
Value investing is an investment paradigm that derives from the ideas on investment and speculation that Ben Graham and David Dodd began teaching at Columbia Business School in 1928 and subsequently developed in their 1934 text Security Analysis...
approach and focus on earnings and cash flows are characteristic of later private equity investors. Buffett would distinguish himself relative to more traditional leveraged buyout practitioners through his reluctance to use leverage
Leveraged buyout
A leveraged buyout occurs when an investor, typically financial sponsor, acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage...
and hostile techniques in his investments.
KKR and the pioneers of private equity
The industry that is today described as private equity was conceived by a number of corporate financiers, most notably Jerome Kohlberg, Jr.Jerome Kohlberg, Jr.
Jerome Kohlberg, Jr. is an American businessman and early pioneer in the private equity and leveraged buyout industries founding private equity firm Kohlberg Kravis Roberts & Co. and later Kohlberg & Company....
and later his protégé, Henry Kravis
Henry Kravis
Henry R. Kravis is an American businessman and private equity investor. He is the co-founder of Kohlberg Kravis Roberts & Co., a private equity firm with over $62 billion in assets as of 2011. He has an estimated net worth of $3.7 billion as of September 2011, ranked by Forbes as the 88th richest...
. Working for Bear Stearns
Bear Stearns
The Bear Stearns Companies, Inc. based in New York City, was a global investment bank and securities trading and brokerage, until its sale to JPMorgan Chase in 2008 during the global financial crisis and recession...
at the time, Kohlberg and Kravis along with Kravis' cousin George Roberts
George R. Roberts
George R. Roberts is an American financier and was one of the three original partners of Kohlberg Kravis Roberts & Co. , which he co-founded alongside Jerome Kohlberg and first cousin Henry Kravis in 1976.-Biography:...
began a series of what they described as "bootstrap" investments. They targeted family-owned businesses, many of which had been founded in the years following World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
and by the 1960s and 1970s were facing succession issues. Many of these companies lacked a viable or attractive exit for their founders as they were too small to be taken public and the founders were reluctant to sell out to competitors, making a sale to a financial buyer
Financial sponsor
A financial sponsor is a term commonly used to refer to private equity investment firms, particularly those private equity firms that engage in leveraged buyout or LBO transactions....
potentially attractive. Their acquisition of Orkin Exterminating Company
Orkin
Orkin is a pest-control company that is a wholly owned subsidiary of Rollins Inc.-The Orkin Uniform:The most recognized Orkin uniform consists of a white collared shirt with the Orkin logo and red epaulets and pressed khaki pants. The uniform varies depending on an employee’s job function for...
in 1964 is among the first significant leveraged buyout transactions. In the following years, the three Bear Stearns bankers would complete a series of buyouts including Stern Metals (1965), Incom (a division of Rockwood International, 1971), Cobblers Industries (1971) and Boren Clay (1973) as well as Thompson Wire, Eagle Motors and Barrows through their investment in Stern Metals. Although they had a number of highly successful investments, the $27 million investment in Cobblers ended in bankruptcy.
By 1976, tensions had built up between Bear Stearns and Kohlberg, Kravis and Roberts leading to their departure and the formation of Kohlberg Kravis Roberts in that year. Most notably, Bear Stearns executive Cy Lewis had rejected repeated proposals to form a dedicated investment fund within Bear Stearns and Lewis took exception to the amount of time spent on outside activities. Early investors included the Hillman Family By 1978, with the revision of the ERISA regulations, the nascent KKR was successful in raising its first institutional fund with approximately $30 million of investor commitments.
Meanwhile in 1974, Thomas H. Lee
Thomas H. Lee
Thomas H. Lee is an American businessman, financier and investor and is credited with being one of the early pioneers in private equity and specifically leveraged buyouts. Thomas H. Lee Partners , the firm he founded in 1974, is among the oldest and largest private equity firms globally...
founded a new investment firm to focus on acquiring companies through leveraged buyout transactions, one of the earliest independent private equity firms to focus on leveraged buyouts of more mature companies rather than venture capital investments in growth companies. Lee's firm, Thomas H. Lee Partners
Thomas H. Lee Partners
Thomas H. Lee Partners is a private equity firm based in Boston, Massachusetts specializing in leveraged buyouts, growth capital, special situations, industry consolidations, and recapitalizations....
, while initially generating less fanfare than other entrants in the 1980s, would emerge as one of the largest private equity firms globally by the end of the 1990s.
The second half of the 1970s and the first years of the 1980s saw the emergence of several private equity firms that would be survive through the various cycles both in leveraged buyouts and venture capital. Among the firms founded during these years were:
- CinvenCinvenCinven is a British private equity firm founded in 1977 with offices in London, Paris, Frankfurt, Milan and Hong Kong. Currently, the company has raised four funds, with the last one signing up €6.5 billion...
, a European buyout firm, founded in 1977; - Forstmann Little & CompanyForstmann Little & CompanyForstmann, Little & Company is a private equity firm, specializing in leveraged buyouts . At its peak in the late 1990s, Forstmann Little was among the largest private equity firms globally...
one of the largest private equity firms through the end of the 1990s, founded in 1978 by Ted Forstmann, Nick ForstmannNicholas C. ForstmannNicholas C. "Nick" Forstmann was one of the founding partners of Forstmann Little & Company, a private equity firm.After attending The Lawrenceville School, Nicholas Forstmann graduated from Georgetown University in 1969, and began working at the Morgan Guaranty Trust Company...
and Brian LittleWilliam Brian LittleWilliam Brian Little , known as Brian Little, was one of the founding partners of Forstmann Little & Company, a private equity firm. He graduated from Colgate University in 1964, and he later served as the chairman of the Board of Trustees. An art building at Colgate was named Little Hall after...
; - Clayton, Dubilier & Rice founded originally as Clayton & Dubilier, in 1978;
- Welsh, Carson, Anderson & StoweWelsh, Carson, Anderson & StoweWelsh, Carson, Anderson & Stowe is a private equity investment firm in the United States. Founded in 1979, it has organized 14 limited partnerships with total capital over $16 billion and is currently in the process of raising a new $4 billion private equity fund Welsh, Carson Anderson & Stowe XI...
founded by Pat Welsh, Russ Carson, Bruce Anderson and Richard Stowe in 1979; - CandoverCandoverCandover Investments plc is a British-based private equity firm, specialising in arranging and leading large buyouts and buyins. Candover Investments is structured as an investment trust...
, one of the earliest European buyout firms, founded in 1980; and - GTCRGTCRGTCR LLC is a private equity firm focused on leveraged buyout, leveraged recapitalization, growth capital and rollup transactions. As of 2008, it manages more than $8 billion in equity and mezzanine capital invested in a wide range of companies and industries....
and Thoma Cressey (originally Golder Thoma & Cressey, later Golder Thoma Cressey & Rauner) founded in 1980 by Stanley GolderStanley GolderStanley C. Golder was an American financier and venture capitalist.He is the namesake of the Stanley C. Golder Center for the Study of Private Equity at the University of Illinois at Urbana-Champaign, which he graduated ....
, who built the private equity program at First Chicago Corp.First Chicago BankFirst Chicago Bank was a Chicago-based retail and commercial bank tracing its roots back to 1863. Over the years, the bank operated under several names including The First National Bank of Chicago and First Chicago NBD...
that backed Federal ExpressFedExFedEx Corporation , originally known as FDX Corporation, is a logistics services company, based in the United States with headquarters in Memphis, Tennessee...
.
Management buyouts also came into existence in the late 1970s and early 1980s. One of the most notable early management buyout transactions was the acquisition of Harley-Davidson
Harley-Davidson
Harley-Davidson , often abbreviated H-D or Harley, is an American motorcycle manufacturer. Founded in Milwaukee, Wisconsin, during the first decade of the 20th century, it was one of two major American motorcycle manufacturers to survive the Great Depression...
. A group of managers at Harley-Davidson, the motorcycle manufacturer, bought the company from AMF in a leveraged buyout in 1981, but racked up big losses the following year and had to ask for protection from Japanese competitors.
Regulatory and tax changes impact the boom
The advent of the boom in leveraged buyouts in the 1980s was supported by three major legal and regulatory events:- Failure of the Carter tax plan of 1977 - In his first year in office, Jimmy CarterJimmy CarterJames Earl "Jimmy" Carter, Jr. is an American politician who served as the 39th President of the United States and was the recipient of the 2002 Nobel Peace Prize, the only U.S. President to have received the Prize after leaving office...
put forth a revision to the corporate tax system that would have, among other results, reduced the disparity in treatment of interest paid to bondholders and dividends paid to stockholders. Carter's proposals did not achieve support from the business community or Congress and was not enacted. Because of the different tax treatment, the use of leverage to reduce taxes was popular among private equity investors and would become increasingly popular with the reduction of the capital gains tax rate.
- Employee Retirement Income Security ActEmployee Retirement Income Security ActThe Employee Retirement Income Security Act of 1974 is an American federal statute that establishes minimum standards for pension plans in private industry and provides for extensive rules on the federal income tax effects of transactions associated with employee benefit plans...
of 1974 (ERISA) - With the passage of ERISA in 1974, corporate pension funds were prohibited from holding certain risky investments including many investments in privately held companies. In 1975, fundraising for private equity investments cratered, according to the Venture Capital Institute, totaling only $10 million during the course of the year. In 1978, the US Labor Department relaxed certain of the ERISA restrictions, under the "prudent man rule," thus allowing corporate pension funds to invest in private equity resulting in a major source of capital available to invest in venture capital and other private equity. TimeTime (magazine)Time is an American news magazine. A European edition is published from London. Time Europe covers the Middle East, Africa and, since 2003, Latin America. An Asian edition is based in Hong Kong...
reported in 1978 that fund raising had increased from $39 million in 1977 to $570 million just one year later. Additionally, many of these same corporate pension investors would become active buyers of the high yield bondsHigh-yield debtIn finance, a high-yield bond is a bond that is rated below investment grade...
(or junk bonds) that were necessary to complete leveraged buyout transactions.
- Economic Recovery Tax Act of 1981 (ERTA) - On August 15, 1981, Ronald ReaganRonald ReaganRonald Wilson Reagan was the 40th President of the United States , the 33rd Governor of California and, prior to that, a radio, film and television actor....
signed the Kemp-Roth bill, officially known as the Economic Recovery Tax Act of 1981, into law, lowering of the top capital gains tax rate from 28 percent to 20 percent, and making high risk investments even more attractive.
In the years that would follow these events, private equity would experience its first major boom, acquiring some of the famed brands and major industrial powers of American business.
The first private equity boom (1982 to 1993)
The decade of the 1980s is perhaps more closely associated with the leveraged buyout than any decade before or since. For the first time, the public became aware of the ability of private equity to affect mainstream companies and "corporate raiders" and "hostile takeovers" entered the public consciousness. The decade would see one of the largest booms in private equity culminating in the 1989 leveraged buyout of RJR NabiscoRJR Nabisco
RJR Nabisco, Inc., was an American conglomerate formed in 1985 by the merger of Nabisco Brands and R.J. Reynolds Tobacco Company. RJR Nabisco was purchased in 1988 by Kohlberg Kravis Roberts & Co...
, which would reign as the largest leveraged buyout transaction for nearly 17 years. In 1980, the private equity industry would raise approximately $2.4 billion of annual investor commitments and by the end of the decade in 1989 that figure stood at $21.9 billion marking the tremendous growth experienced.
See also
- History of private equity and venture capitalHistory of private equity and venture capitalThe history of private equity and venture capital and the development of these asset classes has occurred through a series of boom and bust cycles since the middle of the 20th century. Within the broader private equity industry, two distinct sub-industries, leveraged buyouts and venture capital...
- Private equity in the 1980sPrivate equity in the 1980sPrivate equity in the 1980s relates to one of the major periods in the history of private equity and venture capital. Within the broader private equity industry, two distinct sub-industries, leveraged buyouts and venture capital experienced growth along parallel although interrelated tracks.The...
- Private equity in the 1990sPrivate equity in the 1990sPrivate equity in the 1990s relates to one of the major periods in the history of private equity and venture capital. Within the broader private equity industry, two distinct sub-industries, leveraged buyouts and venture capital experienced growth along parallel although interrelated tracks.The...
- Private equity in the 21st centuryPrivate equity in the 21st centuryPrivate equity in the 2000s relates to one of the major periods in the history of private equity and venture capital. Within the broader private equity industry, two distinct sub-industries, leveraged buyouts and venture capital experienced growth along parallel although interrelated tracks.The...
- Private equity in the 1980s
- Private equity firms (category)
- Venture capital firms (category)
- Private equity and venture capital investors (category)
- Financial sponsorFinancial sponsorA financial sponsor is a term commonly used to refer to private equity investment firms, particularly those private equity firms that engage in leveraged buyout or LBO transactions....
- Private equity firmPrivate equity firmA private equity firm is an investment manager that makes investments in the private equity of operating companies through a variety of loosely affiliated investment strategies including leveraged buyout, venture capital, and growth capital...
- Private equity fundPrivate equity fundA private equity fund is a collective investment scheme used for making investments in various equity securities according to one of the investment strategies associated with private equity....
- Private equity secondary marketPrivate equity secondary marketIn finance, the private equity secondary market refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds....
- Mezzanine capitalMezzanine capitalMezzanine capital, in finance, refers to a subordinated debt or preferred equity instrument that represents a claim on a company's assets which is senior only to that of the common shares...
- Private investment in public equityPrivate investment in public equityA private investment in public equity, often called a PIPE deal, involves the selling of publicly traded common shares or some form of preferred stock or convertible security to private investors. In the U.S...
- Taxation of Private Equity and Hedge FundsTaxation of private equity and hedge fundsPrivate equity funds and hedge funds are private investment vehicles used to pool investment capital, usually for a small group of large institutional or wealthy individual investors. They are subject to favorable regulatory treatment in most jurisdictions from which they are managed, which allows...
- Investment bankingInvestment bankingAn investment bank is a financial institution that assists individuals, corporations and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities...
- Mergers and acquisitionsMergers and acquisitionsMergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or...