History of private equity and venture capital
Encyclopedia
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
experienced growth along parallel, although interrelated tracks.
Since the origins of the modern private equity industry in 1946, there have been four major epochs marked by three boom and bust cycles. The early history of private equity—from 1946 through 1981—was characterized by relatively small volumes of private equity investment, rudimentary firm organizations and limited awareness of and familiarity with the private equity industry. The first boom and bust cycle, from 1982 through 1993, was characterized by the dramatic surge in leveraged buyout
activity financed by junk bonds and culminating in the massive buyout of RJR Nabisco
before the near collapse of the leveraged buyout industry in the late 1980s and early 1990s. The second boom and bust cycle (from 1992 through 2002) emerged out of the ashes of the savings and loan crisis, the
insider trading scandals, the real estate market collapse and the recession of the early 1990s. This period saw the emergence of more institutionalized private equity firms, ultimately culminating in the massive Dot-com bubble
in 1999 and 2000. The third boom and bust cycle (from 2003 through 2007) came in the wake of the collapse of the Dot-com bubble—leveraged buyouts reach unparalleled size and the institutionalization of private equity firms is exemplified by the Blackstone Group
's 2007 initial public offering.
In its early years through roughly the year 2000, the history of the private equity and venture capital asset classes is best described through a narrative of developments in the United States as private equity in Europe consistently lagged behind the North American industry. With the second private equity boom in the mid-1990s and liberalization of regulation for institutional investors in Europe, the emergence of a mature European private equity market has occurred.
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" (founder of INSEAD
and 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 firm
s 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 AEA Investors
, TA Associates
, Mayfield Fund
, Apax Partners
, New Enterprise Associates
, Oak Investment Partners
and Sevin Rosen Funds
.
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 Computers
, Genentech
, Apple Inc., Electronic Arts
, Compaq
, Federal Express
and LSI Corporation
.
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 Employee Retirement Income Security Act regulations, the nascent KKR was successful in raising its first institutional fund with approximately $30 million of investor commitments. That year, the firm signed a precedent-setting deal to buy the publicly traded Houdaille Industries, which made industrial pipes, for $380 million. It was by far the largest take-private and the time.
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: Cinven
, Forstmann Little & Company
, Welsh, Carson, Anderson & Stowe
, Candover
, and GTCR
.
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.
The beginning of the first boom period in private equity would be marked by the well-publicized success of the Gibson Greetings acquisition in 1982 and would roar ahead through 1983 and 1984 with the soaring stock market driving profitable exits for private equity investors.
In January 1982, former US Secretary of the Treasury William E. Simon
, Ray Chambers
and a group of investors, which would later come to be known as Wesray Capital Corporation
, acquired Gibson Greetings
, a producer of greeting cards. The purchase price for Gibson was $80 million, of which only $1 million was rumored to have been contributed by the investors. By mid-1983, just sixteen months after the original deal, Gibson completed a $290 million IPO and Simon made approximately $66 million. Simon and Wesray would later complete the $71.6 million acquisition of Atlas Van Lines
. The success of the Gibson Greetings investment attracted the attention of the wider media to the nascent boom in leveraged buyouts.
Between 1979 and 1989, it was estimated that there were over 2,000 leveraged buyouts valued in excess of $250 million Notable buyouts of this period (not described elsewhere in this article) include: Malone & Hyde (1984), Wometco Enterprises
(1984), Beatrice Companies
(1985), Sterling Jewelers (1985), Revco Drug Stores
(1986), Safeway
(1986), Southland Corporation
(1987), Jim Walter Corp
(later Walter Industries, Inc., 1987), BlackRock
(1988), Federated Department Stores
(1988), Marvel Entertainment
(1988), Uniroyal Goodrich Tire Company (1988) and Hospital Corporation of America
(1989).
Because of the high leverage on many of the transactions of the 1980s, failed deals occurred regularly, however the promise of attractive returns on successful investments attracted more capital. With the increased leveraged buyout activity and investor interest, the mid-1980s saw a major proliferation of private equity firm
s. Among the major firms founded in this period were: Bain Capital
, Chemical Venture Partners
, Hellman & Friedman
, Hicks & Haas, (later Hicks Muse Tate & Furst), The Blackstone Group
, Doughty Hanson, BC Partners
, and The Carlyle Group
.
Additionally, as the market developed, new niches within the private equity industry began to emerge. In 1982, Venture Capital Fund of America
, the first private equity firm focused on acquiring secondary market
interests in existing private equity fund
s was founded and then, two years later in 1984, First Reserve Corporation
, the first private equity firm focused on the energy sector, was founded.
The growth the industry was hampered by sharply declining returns and certain venture firms began posting losses for the first time. In addition to the increased competition among firms, several other factors impacted returns. The market for initial public offerings cooled in the mid-1980s before collapsing after the stock market crash in 1987 and foreign corporations, particularly from Japan and Korea, flooded early stage companies with capital.
In response to the changing conditions, corporations that had sponsored in-house venture investment arms, including General Electric
and Paine Webber
either sold off or closed these venture capital units. Additionally, venture capital units within Chemical Bank
(today CCMP Capital
) and Continental Illinois National Bank
(today CIVC Partners
), among others, began shifting their focus from funding early stage companies toward investments in more mature companies. Even industry founders J.H. Whitney & Company
and Warburg Pincus
began to transition toward leveraged buyouts and growth capital investments. Many of these venture capital firms attempted to stay close to their areas of expertise in the technology industry by acquiring companies in the industry that had reached certain levels of maturity. In 1989, Prime Computer
was acquired in a $1.3 billion leveraged buyout by J.H. Whitney & Company
in what would prove to be a disastrous transaction. Whitney's investment in Prime proved to be nearly a total loss with the bulk of the proceeds from the company's liquidation paid to the company's creditors.
Although lower profile than their buyout counterparts, new leading venture capital firms were also formed including Draper Fisher Jurvetson
(originally Draper Associates) in 1985 and Canaan Partners
in 1987 among others.
Management of many large publicly traded corporation
s reacted negatively to the threat of potential hostile takeover or corporate raid and pursued drastic defensive measures including poison pill
s, golden parachute
s and increasing debt
levels on the company's balance sheet
. Additionally, the threat of the corporate raid would lead to the practice of "greenmail
", where a corporate raider or other party would acquire a significant stake in the stock of a company and receive an incentive payment (effectively a bribe) from the company in order to avoid pursuing a hostile takeover of the company. Greenmail represented a transfer payment from a company's existing shareholders to a third party investor and provided no value to existing shareholders but did benefit existing managers. The practice of "greenmail" is not typically considered a tactic of private equity investors and is not condoned by market participants.
Among the most notable corporate raiders of the 1980s were Carl Icahn
, Victor Posner
, Nelson Peltz
, Robert M. Bass
, T. Boone Pickens, Harold Clark Simmons
, Kirk Kerkorian
, Sir James Goldsmith, Saul Steinberg
and Asher Edelman
. Carl Icahn
developed a reputation as a ruthless corporate raider after his hostile takeover of TWA
in 1985. The result of that takeover was Icahn systematically selling TWA's assets to repay the debt he used to purchase the company, which was described as asset stripping
. In 1985, Pickens was profiled on the cover of Time magazine as "one of the most famous and controversial businessmen in the U.S." for his pursuit of Unocal, Gulf Oil
and Cities Services
. In later years, many of the corporate raiders would be re-characterized as "Activist shareholder
s".
Many of the corporate raiders were onetime clients of Michael Milken
, whose investment banking
firm Drexel Burnham Lambert
helped raise blind pools of capital with which corporate raiders could make a legitimate attempt to take over a company and provided high-yield debt
financing of the buyouts.
Drexel Burnham raised a $100 million blind pool in 1984 for Nelson Peltz
and his holding company Triangle Industries (later Triarc) to give credibility for takeovers, representing the first major blind pool raised for this purpose. Two years later, in 1986, Wickes Companies, a holding company
run by Sanford Sigoloff raised a $1.2 billion blind pool.
In 1985, Milken raised $750 million for a similar blind pool for Ronald Perelman
which would ultimately prove instrumental in acquiring his biggest target: The Revlon Corporation
. In 1980, Ronald Perelman, the son of a wealthy Philadelphia businessman, and future "corporate raider" having made several small but successful buyouts, acquired MacAndrews & Forbes
, a distributor of licorice extract and chocolate that Perelman's father had tried and failed to acquire 10 years earlier. Perelman would ultimately divest the company's core business and use MacAndrews & Forbes
as a holding company investment vehicle for subsequent leveraged buyouts including Technicolor, Inc.
, Pantry Pride
and Revlon
. Using the Pantry Pride
subsidiary of his holding company, MacAndrews & Forbes Holdings
, Perelman's overtures were rebuffed. Repeatedly rejected by the company's board and management, Perelman continued to press forward with a hostile takeover raising his offer from an initial bid of $47.50 per share until it reached $53.00 per share. After receiving a higher offer from a white knight
, private equity firm Forstmann Little & Company
, Perelman's Pantry Pride finally was able to make a successful bid for Revlon
, valuing the company at $2.7 billion. The buyout would prove troubling, burdened by a heavy debt load. Under Perelman's control, Revlon sold four divisions: two were sold for $1 billion, its vision care division was sold for $574 million and its National Health Laboratories division was spun out to the public market in 1988. Revlon also made acquisitions including Max Factor
in 1987 and Betrix in 1989 later selling them to Procter & Gamble
in 1991. Perelman exited the bulk of his holdings in Revlon through an IPO in 1996 and subsequent sales of stock. As of December 31, 2007, Perelman still retains a minority ownership interest in Revlon. The Revlon takeover, because of its well-known brand, was profiled widely by the media and brought new attention to the emerging boom in leveraged buyout activity.
In later years, Milken and Drexel would shy away from certain of the more "notorious" corporate raiders as Drexel and the private equity industry attempted to move upscale.
came to epitomize the "ruthless capitalism" and "greed" popularly seen to be pervading Wall Street at the time. One of the final major buyouts of the 1980s proved to be its most ambitious and marked both a high water mark and a sign of the beginning of the end of the boom that had begun nearly a decade earlier. In 1989, KKR closed on a $31.1 billion dollar takeover of RJR Nabisco
. It was, at that time and for over 17 years, the largest leverage buyout in history. The event was chronicled in the book, Barbarians at the Gate: The Fall of RJR Nabisco, and later made into a television movie starring James Garner
.
F. Ross Johnson
was the President and CEO of RJR Nabisco
at the time of the leveraged buyout and Henry Kravis was a general partner at Kohlberg Kravis Roberts. The leveraged buyout was in the amount of $25 billion (plus assumed debt), and the battle for control took place between October and November 1988. KKR would eventually prevail in acquiring RJR Nabisco at $109 per share marking a dramatic increase from the original announcement that Shearson Lehman Hutton would take RJR Nabisco private at $75 per share. A fierce series of negotiations and horse-trading ensued which pitted KKR against Shearson Lehman Hutton and later Forstmann Little & Co. Many of the major banking players of the day, including Morgan Stanley
, Goldman Sachs
, Salomon Brothers
, and Merrill Lynch
were actively
involved in advising and financing the parties.
After Shearson Lehman's original bid, KKR quickly introduced a tender offer to obtain RJR Nabisco for $90 per share—a price that enabled it to proceed without the approval of RJR Nabisco's management. RJR's management team, working with Shearson Lehman and Salomon Brothers, submitted a bid of $112, a figure they felt certain would enable them to outflank any response by Kravis's team. KKR's final bid of $109, while a lower dollar figure, was ultimately accepted by the board of directors of RJR Nabisco. KKR's offer was guaranteed, whereas the management offer (backed by Shearson Lehman and Salomon) lacked a "reset", meaning that the final share price might have been lower than their stated $112 per share. Additionally, many in RJR's board of directors had grown concerned at recent disclosures of Ross Johnson' unprecedented golden parachute deal. TIME magazine
featured Ross Johnson on the cover of their December 1988 issue along with the headline, "A
Game of Greed: This man could pocket $100 million from the largest corporate takeover in history. Has the buyout craze gone too far?". KKR's offer was welcomed by the board, and, to some observers, it appeared that their elevation of the reset issue as a deal-breaker in KKR's favor was little more than an excuse to reject Ross Johnson's higher payout of $112 per share. F. Ross Johnson received $53 million from the buyout.
At $31.1 billion of transaction value, RJR Nabisco was by far the largest leveraged buyouts in history. In 2006 and 2007, a number of leveraged buyout transactions were completed that for the first time surpassed the RJR Nabisco leveraged buyout in terms of nominal purchase price. However, adjusted for inflation, none of the leveraged buyouts of the 2006–2007 period would surpass RJR Nabisco. Unfortunately for KKR, size would not equate with success as the high purchase price and debt load would burden the performance of the investment. It had to pump additional equity into the company a year after the buyout closed and years later, when it sold the last of its investment, it had chalked up a $700 million loss.
Interestingly, two years earlier, in 1987, Jerome Kohlberg, Jr.
resigned from Kohlberg Kravis Roberts & Co. over differences in strategy. Kohlberg did not favor the larger buyouts (including Beatrice Companies
(1985) and Safeway
(1986) and would later likely have included the 1989 takeover of RJR Nabisco
), highly leveraged
transactions or hostile takeovers being pursued increasingly by KKR. The split would ultimately prove acrimonious as Kohlberg sued Kravis and Roberts for what he alleged were improper business tactics. The case was later settled out of court. Instead, Kohlberg chose to return to his roots, acquiring smaller, middle-market companies and in 1987, he would found a new private equity firm Kohlberg & Company
along with his son James A. Kohlberg, at the time a KKR executive. Jerome Kohlberg
would continue investing successfully for another seven years before retiring from Kohlberg & Company
in 1994 and turning his firm over to his son.
As the market reached its peak in 1988 and 1989, new private equity firms were founded which would emerge as major investors in the years to follow, including: ABRY Partners
, Coller Capital
, Landmark Partners
, Leonard Green & Partners
and Providence Equity Partners
.
of several large buyouts including Robert Campeau
's 1988 buyout of Federated Department Stores
, the 1986 buyout of the Revco
drug stores, Walter Industries, FEB Trucking and Eaton Leonard. Additionally, the RJR Nabisco deal was showing signs of strain, leading to a recapitalization in 1990 that involved the contribution of $1.7 billion of new equity from KKR. Additionally, in response to the threat of unwelcome LBOs, certain companies adopted a number of techniques, such as the poison pill
, to protect them against hostile takeovers by effectively self-destructing the company if it were to be taken over (these practices are increasingly discredited).
was the investment bank most responsible for the boom in private equity during the 1980s due to its leadership in the issuance of high-yield debt
. The firm was first rocked by scandal on May 12, 1986, when Dennis Levine
, a Drexel managing director and investment banker, was charged with insider trading
. Levine pleaded guilty to four felonies, and implicated one of his recent partners, arbitrage
ur Ivan Boesky
. Largely based on information Boesky promised to provide about his dealings with Milken, the Securities and Exchange Commission initiated an investigation of Drexel on November 17. Two days later, Rudy Giuliani
, the United States Attorney for the Southern District of New York, launched his own investigation.
For two years, Drexel steadfastly denied any wrongdoing, claiming that the criminal and SEC cases were based almost entirely on the statements of an admitted felon
looking to reduce his sentence. However, it was not enough to keep the SEC from suing Drexel in September 1988 for insider trading, stock manipulation, defrauding its clients and stock parking (buying stocks for the benefit of another). All of the transactions involved Milken and his department. Giuliani began seriously considering indicting Drexel under the powerful Racketeer Influenced and Corrupt Organizations Act
(RICO), under the doctrine that companies are responsible for an employee's crimes.
The threat of a RICO indictment, which would have required the firm to put up a performance bond of as much as $1 billion in lieu of having its assets frozen, unnerved many at Drexel. Most of Drexel's capital was borrowed money, as is common with most investment banks and it is difficult to receive credit for firms under a RICO indictment. Drexel's CEO, Fred Joseph said that he had been told that if Drexel were indicted under RICO, it would only survive a month at most.
With literally minutes to go before being indicted, Drexel reached an agreement with the government in which it pleaded nolo contendere
(no contest) to six felonies – three counts of stock parking and three counts of stock manipulation. It also agreed to pay a fine of $650 million – at the time, the largest fine ever levied under securities laws. Milken left the firm after his own indictment in March 1989. Effectively, Drexel was now a convicted felon.
In April 1989, Drexel settled with the SEC, agreeing to stricter safeguards on its oversight procedures. Later that month, the firm eliminated 5,000 jobs by shuttering three departments – including the retail brokerage operation.
Meanwhile, the high-yield debt
markets had begun to shut down in 1989, a slowdown that accelerated into 1990. On February 13, 1990 after being advised by United States Secretary of the Treasury
Nicholas F. Brady
, the U.S. Securities and Exchange Commission (SEC), the New York Stock Exchange
(NYSE) and the Federal Reserve System
, Drexel Burnham Lambert
officially filed for Chapter 11 bankruptcy protection.
, also known as "junk bonds". The collapse of the high yield market in 1989 and 1990 would signal the end of the LBO boom. At that time, many market observers were pronouncing the junk bond market “finished.” This collapse would be due largely to three factors:
Despite the adverse market conditions, several of the largest private equity firms were founded in this period including: Apollo Management, Madison Dearborn
and
TPG Capital.
buyout, and continuing through the end of the decade the private equity industry once again experienced a tremendous boom, both in venture capital (as will be discussed below) and leveraged buyouts with the emergence of brand name firms managing multi-billion dollar sized funds. After declining from 1990 through 1992, the private equity industry began to increase in size raising approximately $20.8 billion of investor commitments in 1992 and reaching a high water mark in 2000 of $305.7 billion, outpacing the growth of almost every other asset class.
s, hostile takeovers, asset stripping
, layoffs, plant closings and outsized profits to investors. As private equity reemerged in the 1990s it began to earn a new degree of legitimacy and respectability. Although in the 1980s, many of the acquisitions made were unsolicited and unwelcome, private equity firms in the 1990s focused on making buyouts attractive propositions for management and shareholders. According to The Economist
, “[B]ig companies that would once have turned up their noses at an approach from a private-equity firm are now pleased to do business with them.” Additionally, private equity investors became increasingly focused on the long term development of companies they
acquired, using less leverage in the acquisition. In the 1980s leverage would routinely represent 85% to 95% of the purchase price of a company as compared to average debt levels between 20% and 40% in leveraged buyouts in the 1990s and the first decade of the 21st century. KKR's 1986 acquisition of Safeway, for example, was completed with 97% leverage and 3% equity contributed by KKR, whereas KKR's acquisition of TXU in 2007 was completed with approximately 19% equity contributed ($8.5 billion of equity out of a total purchase price of $45 billion). Additionally, private equity firms are more likely to make investments in capital expenditures and provide incentives for management to build long-term value.
The Thomas H. Lee Partners
acquisition of Snapple Beverages, in 1992, is often described as the deal that marked the resurrection of the leveraged buyout after several dormant years. Only eight months after buying the company, Lee took Snapple Beverages public
and in 1994, only two years after the original acquisition, Lee sold the company to Quaker Oats for $1.7 billion. Lee was estimated to have made $900 million for himself and his investors from the sale. Quaker Oats would subsequently sell the company, which performed poorly under new management, three years later for only $300 million to Nelson Peltz's Triarc. As a result of the Snapple deal, Thomas H. Lee, who had begun investing in private equity in 1974, would find new prominence in the private equity industry and catapult his Boston-based
Thomas H. Lee Partners
to the ranks of the largest private equity firms.
It was also in this timeframe that the capital markets would start to open up again for private equity transactions. During the 1990–1993 period, Chemical Bank established its position as a key lender to private equity firms under the auspices of pioneering investment banker, James B. Lee, Jr.
(known as Jimmy Lee, not related to Thomas H. Lee). By the mid-1990s, under Jimmy Lee, Chemical had established itself as the largest lender in the financing of leveraged buyouts. Lee built a syndicated leveraged finance business and related advisory businesses including the first dedicated financial sponsor coverage group, which covered private equity firms in much the same way that investment banks had traditionally covered various industry sectors.
The following year, David Bonderman
and James Coulter
, who had worked for Robert M. Bass
during the 1980s completed a buyout of Continental Airlines
in 1993, through their nascent Texas Pacific Group, (today TPG Capital). TPG was virtually alone in its conviction that there was an investment opportunity with the airline. The plan included bringing in a new management team, improving aircraft utilization and focusing on lucrative routes. By 1998, TPG had generated an annual internal rate of return of 55% on its investment. Unlike Carl Icahn
's hostile takeover of TWA
in 1985., Bonderman and Texas Pacific Group were widely hailed as saviors of the airline, marking the change in tone from the 1980s. The buyout of Continental Airlines
would
be one of the few successes for the private equity industry which has suffered several major failures, including the 2008 bankruptcies of ATA Airlines
, Aloha Airlines
and Eos Airlines
.
Among the most notable buyouts of the mid-to-late 1990s included: Duane Reade
(1990 (1997), Sealy Corporation
(1997), KinderCare Learning Centers
(1997), J. Crew (1997), Domino's Pizza
(1998), Regal Entertainment Group
(1998), Oxford Health Plans
(1998) and Petco
(2000).
As the market for private equity matured, so too did its investor base. The Institutional Limited Partner Association was initially founded as an informal networking group for limited partner investors in private equity fund
s in the early 1990s. However the organization would evolve into an advocacy organization for private equity investors with more than 200 member organizations from 10 countries. As of the end of 2007, ILPA members had total assets under management in excess of $5 trillion with more than $850 billion of capital commitments to private equity investments.
and Apple Inc. were able to grow because of private equity or venture funding, as were Cisco
, Genentech
, Microsoft
and Avis
. However, by the end of the 1980s, venture capital returns were relatively low, particularly in comparison with their emerging leveraged buyout cousins, due in part to the competition for hot startups, excess supply of IPOs and the inexperience of many venture capital fund managers. Unlike the leveraged buyout industry, after total capital raised increased to $3 billion in 1983, growth in the venture capital industry remained limited through the 1980s and the first half of the 1990s increasing to just over $4 billion more than a decade later in 1994.
After a shakeout of venture capital managers, the more successful firms retrenched, focusing increasingly on improving operations at their portfolio companies rather than continuously making new investments. Results would begin to turn very attractive, successful and would ultimately generate the venture capital boom of the 1990s. Former Wharton Professor Andrew Metrick refers to these first 15 years of the modern venture capital industry beginning in 1980 as the "pre-boom period" in anticipation of the boom that would begin in 1995 and last through the bursting of the Internet bubble in 2000.
The late 1990s were a boom time for the venture capital, as firms on Sand Hill Road
in Menlo Park
and Silicon Valley
benefited from a huge surge of interest in the nascent Internet and other computer technologies. Initial public offerings of stock for technology and other growth companies were in abundance and venture firms were reaping large windfalls. Among the highest profile technology companies with venture capital backing were Amazon.com
, America Online, E-bay, Intuit, Macromedia
, Netscape
, Sun Microsystems
and Yahoo!
.
The Nasdaq
crash and technology slump that started in March 2000 shook virtually the entire venture capital industry as valuations for startup technology companies collapsed. Over the next two years, many venture firms had been forced to write-off large proportions of their investments and many funds were significantly "under water" (the values of the fund's investments were below the amount of capital invested). Venture capital investors sought to reduce size of commitments they had made to venture capital funds and in numerous instances, investors sought to unload existing commitments for cents on the dollar in the secondary market
. By mid-2003, the venture capital industry had shriveled to about half its 2001 capacity. Nevertheless, PricewaterhouseCoopers' MoneyTree Survey shows that total venture capital investments held steady at 2003 levels through the second quarter of 2005.
Although the post-boom years represent just a small fraction of the peak levels of venture investment reached in 2000, they still represent an increase over the levels of investment from 1980 through 1995. As a percentage of GDP, venture investment was 0.058% percent in 1994, peaked at 1.087% (nearly 19x the 1994 level) in 2000 and ranged from 0.164% to 0.182 % in 2003 and 2004. The revival of an Internet
-driven environment (thanks to deals such as eBay
's purchase of Skype
, the News Corporation
's purchase of MySpace.com, and the very successful Google.com and Salesforce.com
IPOs) have helped to revive the venture capital environment. However, as a percentage of the overall private equity market, venture capital has still not reached its mid-1990s level, let alone its peak in 2000.
. As a result, leveraged buyout activity ground to a halt. The major collapses of former high-fliers including WorldCom, Adelphia Communications, Global Crossing
and Winstar Communications
were among the most notable defaults in the market. In addition to the high rate of default, many investors lamented the low recovery rates achieved
through restructuring or bankruptcy.
Among the most affected by the bursting of the internet and telecom bubbles
were two of the largest and most active private equity firms of the 1990s: Tom Hicks
' Hicks Muse Tate & Furst and Ted Forstmann's Forstmann Little & Company
. These firms were often cited as the highest profile private equity casualties, having invested heavily in technology and telecommunications companies. Hicks Muse's reputation and market position were both damaged by the loss of over $1 billion from minority investments in six telecommunications and 13 Internet companies at the peak of the 1990s stock market bubble. Similarly, Forstmann suffered major losses from investments in McLeodUSA
and XO Communications
. Tom Hicks
resigned from Hicks Muse at the end of 2004 and Forstmann Little was unable to raise a new fund. The treasure of the State of Connecticut, sued Forstmann Little to return the state's $96 million investment to that point
and to cancel the commitment it made to take its total investment to $200 million. The humbling of these private equity titans could hardly have been predicted by their investors in the 1990s and forced fund investors to conduct due diligence
on fund managers more carefully and include greater controls on investments in partnership agreements.
Deals completed during this period tended to be smaller and financed less with high yield debt than in other periods. Private equity firms had to cobble together financing made up of bank loans and mezzanine debt, often with higher equity contributions than had been seen. Private equity firms benefited from the lower valuation multiples. As a result, despite the relatively limited activity, those funds that invested during the adverse market conditions delivered attractive returns to investors. Meanwhile, in Europe LBO activity began to increase as the market continued to mature. In 2001, for the first time, European buyout activity exceeded US activity with $44 billion of deals completed in Europe as compared with just $10.7 billion of deals completed in the US. This was a function of the fact that just six LBOs in excess of $500 million were completed in 2001, against 27 in 2000.
As investors sought to reduce their exposure to the private equity asset class, an area of private equity that was increasingly active in these years was the nascent secondary market
for private equity interests. Secondary transaction volume increased from historical levels of 2% or 3% of private equity commitments to 5% of the addressable market in the early years of the new decade. Many of the largest financial institutions (e.g., Deutsche Bank
, Abbey National
, UBS AG
) sold portfolios of direct investments and “pay-to-play” funds portfolios that were typically used as a means to gain entry to lucrative leveraged finance
and mergers and
acquisitions assignments but had created hundreds of millions of dollars of losses. Some of the most notable financial institutions to complete publicly disclosed secondary transactions during this period include: Chase Capital Partners
(2000), National Westminster Bank
(2000), UBS AG
(2003), Deutsche Bank
(MidOcean Partners
) (2003) Abbey National
(2004) and Bank One (2004).
s.
The combination of decreasing interest rates, loosening lending standards and regulatory changes for publicly traded companies would set the stage for the largest boom private equity had seen. The Sarbanes Oxley
legislation, officially the Public Company Accounting Reform and Investor Protection Act, passed in 2002, in the wake of corporate scandals at Enron
, WorldCom, Tyco
, Adelphia, Peregrine Systems
and Global Crossing
among others, would create a new regime of rules and regulations for publicly traded corporations. In addition to the existing focus on short term earnings rather than long term value creation, many public company executives lamented the extra cost and bureaucracy associated with Sarbanes-Oxley
compliance. For the first time, many large corporations saw private equity ownership as potentially more attractive than remaining public. Sarbanes-Oxley would have the opposite effect on the venture capital industry. The
increased compliance costs would make it nearly impossible for venture capitalists to bring young companies to the public markets and dramatically reduced the opportunities for exits via IPO. Instead, venture capitalists have been forced increasingly to rely on sales to strategic buyers for an exit of their investment.
Interest rates, which began a major series of decreases in 2002 would reduce the cost of borrowing and increase the ability of private equity firms to finance large acquisitions. Lower interest rates would encourage investors to return to relatively dormant high-yield debt
and leveraged loan
markets, making debt more readily available to finance buyouts. Additionally, alternative investments also became increasingly important as investors focused on yields despite increases in risk. This search for higher yielding investments would fuel larger funds, allowing larger deals, never before thought possible, to become reality.
Certain buyouts were completed in 2001 and early 2002, particularly in Europe where financing was more readily available. In 2001, for example, BT Group
agreed to sell its international yellow pages directories business (Yell Group
) to Apax Partners
and Hicks, Muse, Tate & Furst for £2.14 billion (approximately $3.5 billion at the time), making it then the largest non-corporate LBO in European history. Yell later bought US directories publisher McLeodUSA for about $600 million, and floated on London's FTSE
in 2003.
at the end of 2002 and 2003, large multi-billion dollar U.S. buyouts could once again obtain significant high yield debt financing and larger transactions could be completed. The Carlyle Group, Welsh, Carson, Anderson & Stowe
, along with other private investors, led a $7.5 billion buyout of QwestDex. The buyout was the third largest corporate buyout since 1989. QwestDex's purchase occurred in two stages: a $2.75 billion acquisition of assets known as Dex Media East in November 2002 and a $4.30 billion acquisition of assets known as Dex Media West in 2003. R. H. Donnelley Corporation acquired Dex Media in 2006. Shortly after Dex Media, other larger buyouts would be completed signaling the resurgence in private equity was underway. The acquisitions included Burger King
(by Bain Capital
), Jefferson Smurfit (by Madison Dearborn
), Houghton Mifflin
(by Bain Capital
, the Blackstone Group and Thomas H. Lee Partners
) and TRW Automotive
by the Blackstone Group
.
In 2006 USA Today reported retrospectively on the revival of private equity:
By 2004 and 2005, major buyouts were once again becoming common and market observers were stunned by the leverage levels and financing terms obtained by financial sponsor
s in their buyouts. Some of the notable buyouts of this period include: Dollarama
(2004), Toys "R" Us (2004), The Hertz Corporation
(2005), Metro-Goldwyn-Mayer
(2005) and SunGard
(2005).
As 2005 ended and 2006 began, new "largest buyout" records were set and surpassed several times with nine of the top ten buyouts at the end of 2007 having been announced in an 18-month window from the beginning of 2006 through the middle of 2007. Additionally, the buyout boom was not limited to the United States as industrialized countries in Europe and the Asia-Pacific region also saw new records set. In 2006, private equity firms bought 654 U.S. companies for $375 billion, representing 18 times the level of transactions closed in 2003. Additionally, U.S. based private equity firms raised $215.4 billion in investor commitments to 322 funds, surpassing the previous record set in 2000 by 22% and 33% higher than the 2005 fundraising total. However, venture capital funds, which were responsible for much of the fundraising volume in 2000 (the height of the dot-com bubble
), raised only $25.1 billion in 2006, a 2% percent decline from 2005 and a significant decline from its peak. The following year, despite the onset of turmoil in the credit markets in the summer, saw yet another record year of fundraising with $302 billion of investor commitments to 415 funds.
Among the largest buyouts of this period included: Georgia-Pacific Corp (2005), Albertson's
(2006), Equity Office Properties (2006 ), Freescale Semiconductor
(2006), GMAC (2006), HCA
(2006), Kinder Morgan
(2006), Harrah's Entertainment
(2006), TDC A/S
(2006), Sabre Holdings
(2006), Travelport
(2006), Alliance Boots
(2007), Biomet
(2007), Chrysler
(2007), First Data
(2007) and TXU
(2007).
attracted significantly greater attention when several of the largest private equity firms pursued various options through the public markets. Taking private equity firms and private equity funds public appeared an unusual move since private equity funds often buy public companies listed on exchange and then take them private. Private equity firms are rarely subject to the quarterly reporting requirements of the public markets and tout this independence to prospective sellers as a key advantage of going private. Nevertheless, there are fundamentally two separate opportunities that private equity firms pursued in the public markets. These options involved a public listing of either:
In May 2006, Kohlberg Kravis Roberts raised $5 billion in an initial public offering for a new permanent investment vehicle (KKR Private Equity Investors or KPE) listing it on the Euronext
exchange in Amsterdam
(ENXTAM: KPE). KKR raised more than three times what it had expected at the outset as many of the investors in KPE were hedge funds seeking exposure to private equity but could not make long term commitments to private equity funds. Because private equity had been booming in the preceding years, the proposition of investing in a KKR fund appeared attractive to certain investors.
KPE's first-day performance was lackluster, trading down 1.7% and trading volume was limited. Initially, a handful of other private equity firms, including Blackstone, and hedge funds had planned to follow KKR's lead but when KPE was increased to $5 billion, it soaked up all the demand. That together with the slump of KPE's shares caused the other firms shelved their plans. KPE's stock declined from an IPO price of €25 per share to €18.16 (a 27% decline) at the end of 2007 and a low of €11.45 (a 54.2% decline) per share in Q1 2008. KPE disclosed in May 2008 that it had completed approximately $300 million of secondary sales
of selected limited
partnership interests in and undrawn commitments to certain KKR-managed funds in order to generate liquidity and repay borrowings.
On March 22, 2007, after nine months of secret preparations, the Blackstone Group filed with the SEC to raise $4 billion in an initial public offering. On June 21, Blackstone sold a 12.3% stake in its ownership to the public for $4.13 billion in the largest U.S. IPO since 2002. Traded on the New York Stock Exchange under the ticker symbol BX, Blackstone priced at $31 per share on June 22, 2007.
Less than two weeks after the Blackstone Group IPO, rival firm Kohlberg Kravis Roberts filed with the SEC in July 2007 to raise $1.25 billion by selling an ownership interest in its management company. KKR had previously listed its KKR Private Equity Investors (KPE) private equity fund vehicle in 2006. The onset of the credit crunch and the shutdown of the IPO market would dampen the prospects of obtaining a valuation that would be attractive to KKR and the flotation was repeatedly postponed.
Meanwhile, other private equity investors were seeking to realize a portion of the value locked into their firms. In September 2007, the Carlyle Group
sold a 7.5% interest in its management company to Mubadala Development Company, which is owned by the Abu Dhabi Investment Authority
(ADIA) for $1.35 billion, which valued Carlyle at approximately $20 billion. Similarly, in January 2008, Silver Lake Partners
sold a 9.9% stake in its management company to the California Public Employees' Retirement System (CalPERS)
for $275 million.
Additionally, Apollo Management completed a private placement of shares in its management company in July 2007. By pursuing a private placement rather than a public offering, Apollo would be able to avoid much of the public scrutiny applied to Blackstone and KKR. In April 2008, Apollo filed with the SEC to permit some holders of its privately traded stock to sell their shares on the New York Stock Exchange
. In April 2004, Apollo raised $930 million for a listed business development company
, Apollo Investment Corporation (NASDAQ: AINV), to invest primarily in middle-market companies in the form of mezzanine debt and senior secured loans
, as well as by making direct equity investments in
companies. The Company also invests in the securities of public companies.
Historically, in the United States, there had been a group of publicly traded private equity firms that were registered as business development companies (BDCs) under the Investment Company Act of 1940
. Typically, BDCs are structured similar to real estate investment trust
s (REITs) in that the BDC structure reduces or eliminates corporate income tax. In return, REITs are required to distribute
90% of their income
, which may be taxable to its investor
s. As of the end of 2007, among the largest BDCs (by market value, excluding Apollo Investment Corp, discussed earlier) are: American Capital Strategies
(NASDAQ: ACAS), Allied Capital Corp((NASDAQ:ALD), Ares Capital Corporation (NASDAQ:ARCC),
Gladstone Investment Corp (NASDAQ:GAIN) and Kohlberg Capital Corp
(NASDAQ:KCAP).
Beginning in 2004 and extending through 2007, the secondary market transformed into a more efficient market in which assets for the first time traded at or above their estimated fair values and liquidity increased dramatically. During these years, the secondary market transitioned from a niche sub-category in which the majority of sellers were distressed to an active market with ample supply of assets and numerous market participants. By 2006 active portfolio management had become far more common in the increasingly developed secondary market and an increasing number of investors had begun to pursue secondary sales to rebalance their private equity portfolios. The continued evolution of the private equity secondary market reflected the maturation and evolution of the larger private equity industry. Among the most notable publicly disclosed secondary transactions
(it is estimated that over two-thirds of secondary market activity is never disclosed publicly): CalPERS (2008), Ohio Bureau of Workers' Compensation
(2007), MetLife (2007), Bank of America
(2006 and 2007), Mellon Financial Corporation (2006), American Capital Strategies
(2006), JPMorgan Chase, Temasek Holdings
, Dresdner Bank
and Dayton Power & Light.
, spilled over into the leveraged finance
and high-yield debt
markets. The markets had been highly robust during the first six months of 2007, with highly issuer friendly developments including PIK and PIK Toggle
(interest is "Payable In Kind") and covenant light
debt widely available to finance large leveraged buyouts. July and August saw a notable slowdown in issuance levels in the high yield and leveraged loan markets with only few issuers accessing the market. Uncertain market
conditions led to a significant widening of yield spreads, which coupled with the typical summer slowdown led to many companies and investment banks to put their plans to issue debt on hold until the autumn. However, the expected rebound in the market after Labor Day
2007 did not materialize and the lack of market confidence prevented deals from pricing. By the end of September, the full extent of the credit situation became obvious as major lenders including Citigroup
and UBS AG
announced major writedowns due to credit losses. The leveraged finance markets came to a near standstill. As a result of the sudden change in the market, buyers would begin to withdraw from or renegotiate the deals completed at the top of the market, most notably in transactions involving: Harman International (announced and withdrawn 2007), Sallie Mae (announced 2007 but
withdrawn 2008), Clear Channel Communications
(2007) and BCE
(2007).
Additionally, the credit crunch has prompted buyout firms to pursue a new group of transactions in order to deploy their massive investment funds. These transactions have included Private Investment in Public Equity
(or PIPE) transactions as well as purchases of debt in existing leveraged buyout transactions. Some of the most notable of these transactions completed in the depths of the credit crunch include Apollo Management's acquisition of the Citigroup
Loan Portfolio (2008) and TPG Capital's PIPE
investment in Washington Mutual
(2008). According to investors and fund managers, the consensus among industry members in late 2009 was that private equity firms will need to become more like asset managers, offering buyouts as just part of their portfolio, or else focus tightly on specific sectors in order to prosper. The industry must also become better in adding value by turning businesses around rather than pure financial engineering.
Two other works were pivotal in framing the image of buyout firms.Barbarians at the Gate, the 1990 best seller about the fight over RJR Nabisco linked private equity to hostile takeovers and assaults on management. A blistering story on the front page of the Wall Street Journal the same year about KKR's buyout of the Safeway supermarket chain painted a much more damaging picture. The piece, which later won a Pulitzer Prize, began with the suicide of a Safeway worker in Texas who had been laid off and went on to chronicle how KKR had sold off hundreds of stores after the buyout and slashed jobs.
2003 film Fahrenheit 9-11. The film suggested that The Carlyle Group exerted tremendous influence on U.S. government policy and contracts through their relationship with the president’s father, George H. W. Bush
, a former senior adviser to the Carlyle Group. Additionally, Moore cited relationships with the Bin Laden family. The movie quotes author Dan Briody claiming that the Carlyle Group "gained" from September 11 because it owned United Defense
, a military contractor, although the firm’s $11 billion Crusader artillery rocket system developed for the U.S. Army is one of the only weapons systems canceled by the Bush administration.
Over the next few years, attention intensified on private equity as the size of transactions and profile of the companies increased. The attention would increase significantly following a series of events involving The Blackstone Group: the firm's initial public offering and the birthday celebration of its CEO. The Wall Street Journal observing Blackstone Group's
Steve Schwarzman's 60th birthday celebration in February 2007 described the event as follows:
Schwarzman received a severe backlash from both critics of the private equity industry and fellow investors in private equity. The lavish event which reminded many of the excesses of notorious executives including Bernie Ebbers (WorldCom) and Dennis Kozlowski
(Tyco International
). David Bonderman
, the founder of TPG Capital remarked, "We have all wanted to be private – at least until now. When Steve Schwarzman's biography with all the dollar signs is posted on the web site none of us will like the furor that results – and that's even if you like Rod Stewart." As the IPO drew closer, there were moves by a number of congressman and senators to block the stock offering and to raise taxes on private equity firms and/or their partners—proposals many attributed in part to the extravagance of the party.
Rubinstein's fears would be confirmed when in 2007, the Service Employees International Union
launched a campaign against private equity firms, specifically the largest buyout firms through public events, protests as well as leafleting and web campaigns. A number of leading private equity executives were targeted by the union members however the SEIU's campaign was non nearly as effective at slowing the buyout boom as the credit crunch of 2007 and 2008 would ultimately prove to be.
In 2008, the SEIU would shift part of its focus from attacking private equity firms directly toward the highlighting the role of sovereign wealth fund
s in private equity. The SEIU pushed legislation in California that would disallow investments by state agencies (particularly CalPERS and CalSTRS
) in firms with ties to certain sovereign wealth funds. Additionally, the SEIU has attempted to criticize the treatment of taxation of carried interest
. The SEIU, and other critics, point out that many wealthy private equity investors pay taxes at lower rates (because the majority of their income is derived from carried interest
, payments received from the profits on a private equity fund
's investments) than many of the rank and file employees of a private equity
firm's portfolio companies.
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....
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...
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
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.
Since the origins of the modern private equity industry in 1946, there have been four major epochs marked by three boom and bust cycles. The early history of private equity—from 1946 through 1981—was characterized by relatively small volumes of private equity investment, rudimentary firm organizations and limited awareness of and familiarity with the private equity industry. The first boom and bust cycle, from 1982 through 1993, was characterized by the dramatic surge in leveraged buyout
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...
activity financed by junk bonds and culminating in the massive buyout of RJR Nabisco
RJR 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...
before the near collapse of the leveraged buyout industry in the late 1980s and early 1990s. The second boom and bust cycle (from 1992 through 2002) emerged out of the ashes of the savings and loan crisis, the
insider trading scandals, the real estate market collapse and the recession of the early 1990s. This period saw the emergence of more institutionalized private equity firms, ultimately culminating in the massive Dot-com bubble
Dot-com bubble
The dot-com bubble was a speculative bubble covering roughly 1995–2000 during which stock markets in industrialized nations saw their equity value rise rapidly from growth in the more...
in 1999 and 2000. The third boom and bust cycle (from 2003 through 2007) came in the wake of the collapse of the Dot-com bubble—leveraged buyouts reach unparalleled size and the institutionalization of private equity firms is exemplified by the Blackstone Group
Blackstone Group
The Blackstone Group L.P. is an American-based alternative asset management and financial services company that specializes in private equity, real estate, and credit and marketable alternative investment strategies, as well as financial advisory services, such as mergers and acquisitions ,...
's 2007 initial public offering.
In its early years through roughly the year 2000, the history of the private equity and venture capital asset classes is best described through a narrative of developments in the United States as private equity in Europe consistently lagged behind the North American industry. With the second private equity boom in the mid-1990s and liberalization of regulation for institutional investors in Europe, the emergence of a mature European private equity market has occurred.
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" (founder of INSEAD
INSEAD
INSEAD is an international graduate business school and research institution. It has campuses in Europe , Asia , and the Middle East , as well as a research center in Israel...
and 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 (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 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 firm
Private equity firm
A 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...
s 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 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 AEA Investors
AEA Investors
AEA Investors is one of the oldest private equity investment firm in the United States. The firm focuses on leveraged buyout, growth capital and mezzanine capital investments in manufacturing, service, distribution, specialty chemicals, consumer product and business services companies in the...
, TA Associates
TA Associates
TA 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...
, Mayfield Fund
Mayfield Fund
Mayfield 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....
, Apax Partners
Apax Partners
Apax 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...
, New Enterprise Associates
New Enterprise Associates
New 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...
, Oak Investment Partners
Oak Investment Partners
Oak 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....
and Sevin Rosen Funds
Sevin Rosen Funds
Sevin 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...
.
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 Computers
Tandem Computers
Tandem 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...
, Genentech
Genentech
Genentech 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...
, Apple Inc., Electronic Arts
Electronic Arts
Electronic 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...
, Compaq
Compaq
Compaq 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....
, Federal Express
FedEx
FedEx Corporation , originally known as FDX Corporation, is a logistics services company, based in the United States with headquarters in Memphis, Tennessee...
and LSI Corporation
LSI Corporation
LSI 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:...
.
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
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
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 Employee Retirement Income Security Act regulations, the nascent KKR was successful in raising its first institutional fund with approximately $30 million of investor commitments. That year, the firm signed a precedent-setting deal to buy the publicly traded Houdaille Industries, which made industrial pipes, for $380 million. It was by far the largest take-private and the time.
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: Cinven
Cinven
Cinven 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...
, Forstmann Little & Company
Forstmann Little & Company
Forstmann, 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...
, Welsh, Carson, Anderson & Stowe
Welsh, Carson, Anderson & Stowe
Welsh, 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...
, Candover
Candover
Candover 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...
, and GTCR
GTCR
GTCR 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....
.
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 parts 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 (1982–1993)
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.
Beginning of the LBO boom
In January 1982, former US Secretary of the Treasury William E. Simon
William E. Simon
William Edward Simon was a businessman, a Secretary of Treasury of the U.S. for three years, and a philanthropist. He became the 63rd Secretary of the Treasury on May 8, 1974, during the Nixon administration. He was reappointed by President Ford and served until 1977. Outside of government, he was...
, Ray Chambers
Ray Chambers
Raymond G. Chambers currently serves as United Nations Secretary-General’s Special Envoy for Malaria. He was appointed to this position by Secretary-General Ban Ki-moon in February 2008...
and a group of investors, which would later come to be known as Wesray Capital Corporation
Wesray Capital Corporation
Wesray Capital Corporation was an early private equity firm focussing on leveraged buyout investments. The firm was founded by former US Secretary of the Treasury William E...
, acquired Gibson Greetings
American Greetings
American Greetings Corporation, Inc. is the world's largest publicly-traded greeting card company. It is based in Brooklyn, Ohio and sells paper greeting cards, electronic greeting cards, party products , and electronic expressive content...
, a producer of greeting cards. The purchase price for Gibson was $80 million, of which only $1 million was rumored to have been contributed by the investors. By mid-1983, just sixteen months after the original deal, Gibson completed a $290 million IPO and Simon made approximately $66 million. Simon and Wesray would later complete the $71.6 million acquisition of Atlas Van Lines
Atlas Van Lines
Atlas Van Lines is a moving company formed in 1948 by a group of local transfer and storage firms. As an agent-owned company it is similar in form to a cooperative. It has about 500 agents worldwide , of which 75 own shares in Atlas World Group, which controls Atlas Van Lines and other related...
. The success of the Gibson Greetings investment attracted the attention of the wider media to the nascent boom in leveraged buyouts.
Between 1979 and 1989, it was estimated that there were over 2,000 leveraged buyouts valued in excess of $250 million Notable buyouts of this period (not described elsewhere in this article) include: Malone & Hyde (1984), Wometco Enterprises
Wometco Enterprises
Wometco Enterprises is a company headquartered in Coral Gables, Florida; a suburb of Miami. It was a large media company but today it is known only as the owner of the Miami Seaquarium.- History :...
(1984), Beatrice Companies
Beatrice Foods
Beatrice Foods Company was a major American food processing company. In 1987, its smaller international food operations were sold to Reginald Lewis, a corporate attorney creating TLC Beatrice International, after which the majority of its domestic brands and assets were acquired by Kohlberg,...
(1985), Sterling Jewelers (1985), Revco Drug Stores
Revco
Revco Discount Drug Stores , once based in Twinsburg, Ohio, was a major drug store chain operating through the Ohio Valley, the Mid-Atlantic states, and the Southeastern United States. The chain's stock was traded on the New York Stock Exchange under the ticker RXR...
(1986), Safeway
Safeway Inc.
Safeway Inc. , a Fortune 500 company, is North America's second largest supermarket chain after The Kroger Co., with, as of December 2010, 1,694 stores located throughout the western and central United States and western Canada. It also operates some stores in the Mid-Atlantic region of the Eastern...
(1986), Southland Corporation
7-Eleven
7-Eleven is part of an international chain of convenience stores, operating under Seven-Eleven Japan Co. Ltd, which in turn is owned by Seven & I Holdings Co...
(1987), Jim Walter Corp
James W. Walter, Sr.
James W. Walter, Sr. , of Tampa, Florida in the United States, was a home builder who started Jim Walter Homes and Walter Industries, now doing business as Walter Energy, Inc., a leading producer of metallurgical coal for the global steel industry, in 1946 with $1,000 he borrowed from his father...
(later Walter Industries, Inc., 1987), BlackRock
BlackRock
BlackRock, Inc. is an American multinational investment management corporation and the world's largest asset manager. BlackRock is headquartered in Manhattan, New York City, New York, United States and is the leading provider of investment, advisory, and risk management solutions...
(1988), Federated Department Stores
Federated Department Stores
Macy's, Inc. is a department store holding company and owner of Macy's and Bloomingdale's department stores. Macy's Inc.'s stores specialize mostly in retail clothing, jewelery, watches, dinnerware, and furniture....
(1988), Marvel Entertainment
Marvel Entertainment
Marvel Entertainment, LLC , formerly Marvel Enterprises and Toy Biz, Inc., is an American entertainment company formed from the merger of Marvel Entertainment Group, Inc. and Toy Biz, Inc....
(1988), Uniroyal Goodrich Tire Company (1988) and Hospital Corporation of America
Hospital Corporation of America
Hospital Corporation of America is the largest private operator of health care facilities in the world, It is based in Nashville, Tennessee and is widely considered to be the single largest factor in making that city a hotspot for healthcare enterprise.-History:The founders of HCA include Jack C....
(1989).
Because of the high leverage on many of the transactions of the 1980s, failed deals occurred regularly, however the promise of attractive returns on successful investments attracted more capital. With the increased leveraged buyout activity and investor interest, the mid-1980s saw a major proliferation of private equity firm
Private equity firm
A 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...
s. Among the major firms founded in this period were: Bain Capital
Bain Capital
Bain Capital LLC is a Boston-based private equity firm founded in 1984 by partners from the consulting firm Bain & Company. Originally conceived as an early-stage, growth-oriented investment fund, Bain Capital today manages approximately $65 billion in assets, and its strategies include private...
, Chemical Venture Partners
CCMP Capital
CCMP Capital is a private equity investment firm that focuses on leveraged buyout and growth capital transactions. Formerly known as JP Morgan Partners, the investment professionals of JP Morgan Partners separated from JPMorgan Chase on July 31, 2006. CCMP has invested approximately $12 billion...
, Hellman & Friedman
Hellman & Friedman
Hellman & Friedman is a private equity firm, founded in 1984 by Warren Hellman and Tully Friedman, that makes investments primarily through leveraged buyouts and minority growth capital investments....
, Hicks & Haas, (later Hicks Muse Tate & Furst), The Blackstone Group
Blackstone Group
The Blackstone Group L.P. is an American-based alternative asset management and financial services company that specializes in private equity, real estate, and credit and marketable alternative investment strategies, as well as financial advisory services, such as mergers and acquisitions ,...
, Doughty Hanson, BC Partners
BC Partners
BC Partners is a private equity firm specialising in buyouts and acquisitions financing in Europe and the United States. The firm invests across all industries...
, and The Carlyle Group
Carlyle Group
The Carlyle Group is an American-based global asset management firm, specializing in private equity, based in Washington, D.C. The Carlyle Group operates in four business areas: corporate private equity, real assets, market strategies and fund-of-funds, through its AlpInvest subsidiary...
.
Additionally, as the market developed, new niches within the private equity industry began to emerge. In 1982, Venture Capital Fund of America
Dayton Carr
Dayton Carr is the founder of Venture Capital Fund of America a private equity firm that is credited with inventing the Private equity secondary market....
, the first private equity firm focused on acquiring secondary market
Private equity secondary market
In 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....
interests in existing 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....
s was founded and then, two years later in 1984, First Reserve Corporation
First Reserve Corporation
First Reserve Corporation is a private equity firm specializing in leveraged buyouts and growth capital investments in the energy sector. First Reserve was founded in 1984 and is the oldest private equity dedicated to investments in the energy sector.....
, the first private equity firm focused on the energy sector, was founded.
Venture capital in the 1980s
The public successes of the venture capital industry in the 1970s and early 1980s (e.g., DEC, Apple, Genentech) gave rise to a major proliferation of venture capital investment firms. From just a few dozen firms at the start of the decade, there were over 650 firms by the end of the 1980s, each searching for the next major "home run". While the number of firms multiplied, the capital managed by these firms increased only 11% from $28 billion to $31 billion over the course of the decade.The growth the industry was hampered by sharply declining returns and certain venture firms began posting losses for the first time. In addition to the increased competition among firms, several other factors impacted returns. The market for initial public offerings cooled in the mid-1980s before collapsing after the stock market crash in 1987 and foreign corporations, particularly from Japan and Korea, flooded early stage companies with capital.
In response to the changing conditions, corporations that had sponsored in-house venture investment arms, including General Electric
General Electric
General Electric Company , or GE, is an American multinational conglomerate corporation incorporated in Schenectady, New York and headquartered in Fairfield, Connecticut, United States...
and Paine Webber
Paine Webber
Paine Webber and Company was an American stock brokerage and asset management firm that was acquired by the Swiss bank UBS AG in 2000. The company was founded in 1880 in Boston, Massachusetts, by William Alfred Paine and Wallace G. Webber. Operating with two employees, they leased premises at 48...
either sold off or closed these venture capital units. Additionally, venture capital units within Chemical Bank
Chemical Banking
Chemical Bank was a bank with headquarters in New York City from 1824 until 1996. The bank operated as the primary subsidiary of the Chemical Banking Corporation, a bank holding company established in 1988. At the end of 1995, Chemical was the third largest bank in the U.S...
(today CCMP Capital
CCMP Capital
CCMP Capital is a private equity investment firm that focuses on leveraged buyout and growth capital transactions. Formerly known as JP Morgan Partners, the investment professionals of JP Morgan Partners separated from JPMorgan Chase on July 31, 2006. CCMP has invested approximately $12 billion...
) and Continental Illinois National Bank
Continental Illinois National Bank and Trust Company
The Continental Illinois National Bank and Trust Company was at one time the seventh-largest bank in the United States as measured by deposits with approximately $40 billion in assets. In 1984, Continental Illinois became the largest ever bank failure in U.S. history, when a run on the bank led to...
(today CIVC Partners
CIVC Partners
CIVC Partners, previously known as Continental Illinois Venture Corporation, is a Chicago-based private equity firm that presently has over $1.3 billion of equity capital under management. The firm's predecessor was established in 1970 as a subsidiary of Continental Illinois National Bank and Trust...
), among others, began shifting their focus from funding early stage companies toward investments in more mature companies. Even industry founders 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...
and 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...
began to transition toward leveraged buyouts and growth capital investments. Many of these venture capital firms attempted to stay close to their areas of expertise in the technology industry by acquiring companies in the industry that had reached certain levels of maturity. In 1989, Prime Computer
Prime Computer
Prime Computer, Inc. was a Natick, Massachusetts-based producer of minicomputers from 1972 until 1992. The alternative spellings "PR1ME" and "PR1ME Computer" were used as brand names or logos by the company.-Founders:...
was acquired in a $1.3 billion leveraged buyout by 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...
in what would prove to be a disastrous transaction. Whitney's investment in Prime proved to be nearly a total loss with the bulk of the proceeds from the company's liquidation paid to the company's creditors.
Although lower profile than their buyout counterparts, new leading venture capital firms were also formed including Draper Fisher Jurvetson
Draper Fisher Jurvetson
Draper Fisher Jurvetson is a venture capital firm based in Menlo Park, California with affiliate offices in more than 30 cities around the world and over $7 billion in capital commitments....
(originally Draper Associates) in 1985 and Canaan Partners
Canaan Partners
Canaan Partners is a multi-billion dollar global venture capital firm focusing on investments in early stage companies in the technology and healthcare sectors....
in 1987 among others.
Corporate raiders, hostile takeovers and greenmail
Although buyout firms generally had different aims and methods, they were often lumped in with the "corporate raiders" who came on the scene in the 1980s. The raiders were best known for hostile bids—takeover attempts that were opposed by management. By contrast, private equity firms generally attempted to strike deals with boards and CEOs, though in many cases in the 1980s they allied with managements that were already under pressure from raiders. But both groups bought companies through leveraged buyouts; both relied heavily on junk bond financing; and under both types of owners in many cases major assets were sold, costs were slashed and employees were laid off. Hence, in the public mind, they were lumped together.Management of many large publicly traded corporation
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
s reacted negatively to the threat of potential hostile takeover or corporate raid and pursued drastic defensive measures including poison pill
Poison pill
A shareholder rights plan, colloquially known as a "poison pill", or simply "the pill" is a type of defensive tactic used by a corporation's board of directors against a takeover...
s, golden parachute
Golden parachute
A golden parachute is an agreement between a company and an employee specifying that the employee will receive certain significant benefits if employment is terminated. Sometimes, certain conditions, typically a change in company ownership, must be met, but often the cause of termination is...
s and increasing debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
levels on the company's balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
. Additionally, the threat of the corporate raid would lead to the practice of "greenmail
Greenmail
Greenmail or greenmailing is the practice of purchasing enough shares in a firm to threaten a takeover and thereby forcing the target firm to buy those shares back at a premium in order to suspend the takeover....
", where a corporate raider or other party would acquire a significant stake in the stock of a company and receive an incentive payment (effectively a bribe) from the company in order to avoid pursuing a hostile takeover of the company. Greenmail represented a transfer payment from a company's existing shareholders to a third party investor and provided no value to existing shareholders but did benefit existing managers. The practice of "greenmail" is not typically considered a tactic of private equity investors and is not condoned by market participants.
Among the most notable corporate raiders of the 1980s were Carl Icahn
Carl Icahn
Carl Celian Icahn is an American business magnate and investor.-Biography:Icahn was raised in Far Rockaway, Queens, New York City, where he attended Far Rockaway High School. His father was a cantor, his mother was a schoolteacher...
, 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:...
, 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 :...
, Robert M. Bass
Robert Bass
Robert Muse Bass is an American businessman and philanthropist. He is currently the chairman of Aerion Corporation, an American aerospace firm in Reno, Nevada. Bass is worth approximately $5.5 billion as of 2007, and $4 billion in 2010 on oil and other investments-Life:Bass was born into a wealthy...
, T. Boone Pickens, Harold Clark Simmons
Harold Clark Simmons
Harold Clark Simmons is an American businessman and billionaire whose banking expertise helped him develop the acquisition concept known as the leveraged buyout to acquire various corporations. He is the owner of Contran Corporation and of Valhi, Inc.,...
, Kirk Kerkorian
Kirk Kerkorian
Kerkor "Kirk" Kerkorian is an American businessman who is the president/CEO of Tracinda Corporation, his private holding company based in Beverly Hills, California. Kerkorian is known as one of the important figures in shaping Las Vegas and, with architect Martin Stern, Jr...
, Sir James Goldsmith, 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...
and Asher Edelman
Asher Edelman
Asher Edelman began his career on Wall Street in 1961. In 1969 he formed Mack, Bushnell and Edelman where he was CEO. Edelman’s Wall Street businesses included Investment Banking, Money Management, and Derivatives Trading...
. Carl Icahn
Carl Icahn
Carl Celian Icahn is an American business magnate and investor.-Biography:Icahn was raised in Far Rockaway, Queens, New York City, where he attended Far Rockaway High School. His father was a cantor, his mother was a schoolteacher...
developed a reputation as a ruthless corporate raider after his hostile takeover of TWA
Trans World Airlines
Trans World Airlines was an American airline that existed from 1925 until it was bought out by and merged with American Airlines in 2001. It was a major domestic airline in the United States and the main U.S.-based competitor of Pan American World Airways on intercontinental routes from 1946...
in 1985. The result of that takeover was Icahn systematically selling TWA's assets to repay the debt he used to purchase the company, which was described as asset stripping
Asset stripping
Asset stripping involves selling the assets of a business individually at a profit. The term is generally used in a pejorative sense as such activity is not considered productive to the economy. Asset stripping is considered to be a problem in economies such as Russia or China that are making a...
. In 1985, Pickens was profiled on the cover of Time magazine as "one of the most famous and controversial businessmen in the U.S." for his pursuit of Unocal, Gulf Oil
Gulf Oil
Gulf Oil was a major global oil company from the 1900s to the 1980s. The eighth-largest American manufacturing company in 1941 and the ninth-largest in 1979, Gulf Oil was one of the so-called Seven Sisters oil companies...
and Cities Services
Occidental Petroleum
Occidental Petroleum Corporation is a California-based oil and gas exploration and production company with operations in the United States, the Middle East, North Africa, and South America...
. In later years, many of the corporate raiders would be re-characterized as "Activist shareholder
Activist shareholder
An activist shareholder uses an equity stake in a corporation to put public pressure on its management. The goals of activist shareholders range from financial to non-financial...
s".
Many of the corporate raiders were onetime clients of Michael Milken
Michael Milken
Michael Robert Milken is an American business magnate, financier, and philanthropist noted for his role in the development of the market for high-yield bonds during the 1970s and 1980s, for his 1990 guilty plea to felony charges for violating US securities laws, and for his funding of medical...
, whose investment banking
Investment banking
An 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...
firm Drexel Burnham Lambert
Drexel Burnham Lambert
Drexel Burnham Lambert was a major Wall Street investment banking firm, which first rose to prominence and then was forced into bankruptcy in February 1990 by its involvement in illegal activities in the junk bond market, driven by Drexel employee Michael Milken. At its height, it was the...
helped raise blind pools of capital with which corporate raiders could make a legitimate attempt to take over a company and provided high-yield debt
High-yield debt
In finance, a high-yield bond is a bond that is rated below investment grade...
financing of the buyouts.
Drexel Burnham raised a $100 million blind pool in 1984 for 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 :...
and his holding company Triangle Industries (later Triarc) to give credibility for takeovers, representing the first major blind pool raised for this purpose. Two years later, in 1986, Wickes Companies, a holding company
Holding company
A holding company is a company or firm that owns other companies' outstanding stock. It usually refers to a company which does not produce goods or services itself; rather, its purpose is to own shares of other companies. Holding companies allow the reduction of risk for the owners and can allow...
run by Sanford Sigoloff raised a $1.2 billion blind pool.
In 1985, Milken raised $750 million for a similar blind pool for Ronald Perelman
Ronald Perelman
Ronald Owen Perelman is an American business magnate. Through his company MacAndrews & Forbes Holdings Inc., he has invested in various companies in grocery, cigar, licorice, makeup, car, photography, television, camping, security, lottery, jewelry, banks, and comic book industries.-Early...
which would ultimately prove instrumental in acquiring his biggest target: The Revlon Corporation
Revlon
Revlon is an American cosmetics, skin care, fragrance, and personal care company founded in 1932.-History:Revlon was founded in the midst of the Great Depression, 1932, by Charles Revson and his brother Joseph, along with a chemist, Charles Lachman, who contributed the "L" in the Revlon name...
. In 1980, Ronald Perelman, the son of a wealthy Philadelphia businessman, and future "corporate raider" having made several small but successful buyouts, acquired MacAndrews & Forbes
MacAndrews & Forbes Holdings
MacAndrews & Forbes Holdings, Inc. is the principal holding company used by and wholly owned by businessman and private equity investor, Ronald Perelman...
, a distributor of licorice extract and chocolate that Perelman's father had tried and failed to acquire 10 years earlier. Perelman would ultimately divest the company's core business and use MacAndrews & Forbes
MacAndrews & Forbes Holdings
MacAndrews & Forbes Holdings, Inc. is the principal holding company used by and wholly owned by businessman and private equity investor, Ronald Perelman...
as a holding company investment vehicle for subsequent leveraged buyouts including Technicolor, Inc.
Technicolor
Technicolor is a color motion picture process invented in 1916 and improved over several decades.It was the second major process, after Britain's Kinemacolor, and the most widely used color process in Hollywood from 1922 to 1952...
, Pantry Pride
Pantry Pride
Food Fair, also known by its successor name Pantry Pride, was a large supermarket chain in the United States. It was founded by Samuel N. Friedland, who opened the first store in Harrisburg, Pennsylvania in the late 1920s. As of 1957, Food Fair had 275 stores, and at its peak, the chain had more...
and Revlon
Revlon
Revlon is an American cosmetics, skin care, fragrance, and personal care company founded in 1932.-History:Revlon was founded in the midst of the Great Depression, 1932, by Charles Revson and his brother Joseph, along with a chemist, Charles Lachman, who contributed the "L" in the Revlon name...
. Using the Pantry Pride
Pantry Pride
Food Fair, also known by its successor name Pantry Pride, was a large supermarket chain in the United States. It was founded by Samuel N. Friedland, who opened the first store in Harrisburg, Pennsylvania in the late 1920s. As of 1957, Food Fair had 275 stores, and at its peak, the chain had more...
subsidiary of his holding company, MacAndrews & Forbes Holdings
MacAndrews & Forbes Holdings
MacAndrews & Forbes Holdings, Inc. is the principal holding company used by and wholly owned by businessman and private equity investor, Ronald Perelman...
, Perelman's overtures were rebuffed. Repeatedly rejected by the company's board and management, Perelman continued to press forward with a hostile takeover raising his offer from an initial bid of $47.50 per share until it reached $53.00 per share. After receiving a higher offer from a white knight
White knight (business)
In business, a white knight, or "friendly investor," may be a corporation or a person that intends to help another firm. There are many types of white knights...
, private equity firm Forstmann Little & Company
Forstmann Little & Company
Forstmann, 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...
, Perelman's Pantry Pride finally was able to make a successful bid for Revlon
Revlon
Revlon is an American cosmetics, skin care, fragrance, and personal care company founded in 1932.-History:Revlon was founded in the midst of the Great Depression, 1932, by Charles Revson and his brother Joseph, along with a chemist, Charles Lachman, who contributed the "L" in the Revlon name...
, valuing the company at $2.7 billion. The buyout would prove troubling, burdened by a heavy debt load. Under Perelman's control, Revlon sold four divisions: two were sold for $1 billion, its vision care division was sold for $574 million and its National Health Laboratories division was spun out to the public market in 1988. Revlon also made acquisitions including Max Factor
Max Factor
Max Factor & Company is a cosmetics company, founded during 1909 by Maksymilian Faktorowicz , Max Factor, a Polish-Jewish cosmetician. Max Factor & Company was a related, two-family, multi-generational international cosmetics company before its sale in 1973 for $500 million dollars...
in 1987 and Betrix in 1989 later selling them to Procter & Gamble
Procter & Gamble
Procter & Gamble is a Fortune 500 American multinational corporation headquartered in downtown Cincinnati, Ohio and manufactures a wide range of consumer goods....
in 1991. Perelman exited the bulk of his holdings in Revlon through an IPO in 1996 and subsequent sales of stock. As of December 31, 2007, Perelman still retains a minority ownership interest in Revlon. The Revlon takeover, because of its well-known brand, was profiled widely by the media and brought new attention to the emerging boom in leveraged buyout activity.
In later years, Milken and Drexel would shy away from certain of the more "notorious" corporate raiders as Drexel and the private equity industry attempted to move upscale.
RJR Nabisco and the Barbarians at the Gate
Leveraged buyouts in the 1980s including Perelman's takeover of RevlonRevlon
Revlon is an American cosmetics, skin care, fragrance, and personal care company founded in 1932.-History:Revlon was founded in the midst of the Great Depression, 1932, by Charles Revson and his brother Joseph, along with a chemist, Charles Lachman, who contributed the "L" in the Revlon name...
came to epitomize the "ruthless capitalism" and "greed" popularly seen to be pervading Wall Street at the time. One of the final major buyouts of the 1980s proved to be its most ambitious and marked both a high water mark and a sign of the beginning of the end of the boom that had begun nearly a decade earlier. In 1989, KKR closed on a $31.1 billion dollar takeover of RJR Nabisco
RJR 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...
. It was, at that time and for over 17 years, the largest leverage buyout in history. The event was chronicled in the book, Barbarians at the Gate: The Fall of RJR Nabisco, and later made into a television movie starring James Garner
James Garner
James Garner is an American film and television actor, one of the first Hollywood actors to excel in both media. He has starred in several television series spanning a career of more than five decades...
.
F. Ross Johnson
F. Ross Johnson
-Biography:Born in Winnipeg, Manitoba, into a lower-middle-class family, he used a military cadet scholarship program to attend the University of Manitoba where he graduated in 1952 with a Bachelor of Commerce degree and was a member of the fraternity Phi Delta Theta. He went on to earn an M.B.A....
was the President and CEO of RJR Nabisco
RJR 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...
at the time of the leveraged buyout and Henry Kravis was a general partner at Kohlberg Kravis Roberts. The leveraged buyout was in the amount of $25 billion (plus assumed debt), and the battle for control took place between October and November 1988. KKR would eventually prevail in acquiring RJR Nabisco at $109 per share marking a dramatic increase from the original announcement that Shearson Lehman Hutton would take RJR Nabisco private at $75 per share. A fierce series of negotiations and horse-trading ensued which pitted KKR against Shearson Lehman Hutton and later Forstmann Little & Co. Many of the major banking players of the day, including Morgan Stanley
Morgan Stanley
Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations, governments, financial institutions, and individuals. Morgan Stanley also operates in 36 countries around the world, with over 600 offices and a workforce of over 60,000....
, Goldman Sachs
Goldman Sachs
The Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients...
, Salomon Brothers
Salomon Brothers
Salomon Brothers was a bulge bracket, Wall Street investment bank. Founded in 1910 by three brothers along with a clerk named Ben Levy, it remained a partnership until the early 1980s, when it was acquired by the commodity trading firm Phibro Corporation and then became Salomon Inc. Eventually...
, and Merrill Lynch
Merrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...
were actively
involved in advising and financing the parties.
After Shearson Lehman's original bid, KKR quickly introduced a tender offer to obtain RJR Nabisco for $90 per share—a price that enabled it to proceed without the approval of RJR Nabisco's management. RJR's management team, working with Shearson Lehman and Salomon Brothers, submitted a bid of $112, a figure they felt certain would enable them to outflank any response by Kravis's team. KKR's final bid of $109, while a lower dollar figure, was ultimately accepted by the board of directors of RJR Nabisco. KKR's offer was guaranteed, whereas the management offer (backed by Shearson Lehman and Salomon) lacked a "reset", meaning that the final share price might have been lower than their stated $112 per share. Additionally, many in RJR's board of directors had grown concerned at recent disclosures of Ross Johnson' unprecedented golden parachute deal. TIME magazine
Time (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...
featured Ross Johnson on the cover of their December 1988 issue along with the headline, "A
Game of Greed: This man could pocket $100 million from the largest corporate takeover in history. Has the buyout craze gone too far?". KKR's offer was welcomed by the board, and, to some observers, it appeared that their elevation of the reset issue as a deal-breaker in KKR's favor was little more than an excuse to reject Ross Johnson's higher payout of $112 per share. F. Ross Johnson received $53 million from the buyout.
At $31.1 billion of transaction value, RJR Nabisco was by far the largest leveraged buyouts in history. In 2006 and 2007, a number of leveraged buyout transactions were completed that for the first time surpassed the RJR Nabisco leveraged buyout in terms of nominal purchase price. However, adjusted for inflation, none of the leveraged buyouts of the 2006–2007 period would surpass RJR Nabisco. Unfortunately for KKR, size would not equate with success as the high purchase price and debt load would burden the performance of the investment. It had to pump additional equity into the company a year after the buyout closed and years later, when it sold the last of its investment, it had chalked up a $700 million loss.
Interestingly, two years earlier, in 1987, 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....
resigned from Kohlberg Kravis Roberts & Co. over differences in strategy. Kohlberg did not favor the larger buyouts (including Beatrice Companies
Beatrice Foods
Beatrice Foods Company was a major American food processing company. In 1987, its smaller international food operations were sold to Reginald Lewis, a corporate attorney creating TLC Beatrice International, after which the majority of its domestic brands and assets were acquired by Kohlberg,...
(1985) and Safeway
Safeway Inc.
Safeway Inc. , a Fortune 500 company, is North America's second largest supermarket chain after The Kroger Co., with, as of December 2010, 1,694 stores located throughout the western and central United States and western Canada. It also operates some stores in the Mid-Atlantic region of the Eastern...
(1986) and would later likely have included the 1989 takeover of RJR Nabisco
RJR 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...
), highly leveraged
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
transactions or hostile takeovers being pursued increasingly by KKR. The split would ultimately prove acrimonious as Kohlberg sued Kravis and Roberts for what he alleged were improper business tactics. The case was later settled out of court. Instead, Kohlberg chose to return to his roots, acquiring smaller, middle-market companies and in 1987, he would found a new private equity firm Kohlberg & Company
Kohlberg & Company
Kohlberg & Company is a private equity firm that focuses on leveraged buyout transactions founded by industry pioneer Jerome Kohlberg, Jr.Today, the firm invests in a variety of transactions including leveraged carveouts , take private transactions and acquisitions of privately held companies...
along with his son James A. Kohlberg, at the time a KKR executive. Jerome Kohlberg
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....
would continue investing successfully for another seven years before retiring from Kohlberg & Company
Kohlberg & Company
Kohlberg & Company is a private equity firm that focuses on leveraged buyout transactions founded by industry pioneer Jerome Kohlberg, Jr.Today, the firm invests in a variety of transactions including leveraged carveouts , take private transactions and acquisitions of privately held companies...
in 1994 and turning his firm over to his son.
As the market reached its peak in 1988 and 1989, new private equity firms were founded which would emerge as major investors in the years to follow, including: ABRY Partners
ABRY Partners
ABRY Partners is a private equity firm headquartered in Boston, Massachusetts that focuses on investments in media. Since 1989, the firm has completed over $18.0 billion of leveraged transactions and other private equity and mezzanine investments, representing investments in more than 450 media...
, Coller Capital
Coller Capital
Coller Capital, founded in 1990 by Jeremy Coller, is one of the leading global investors in the Private equity secondary market ....
, Landmark Partners
Landmark Partners
Landmark Partners, founded in 1989, is a leading investor in the Private equity secondary market . It is based in Simsbury, Connecticut.The firm was founded by Stanley Alfeld.-Investment Program:...
, Leonard Green & Partners
Leonard Green & Partners
Leonard Green & Partners is a private equity firm specializing in leveraged buyout transactions, particularly of middle market companies. As of 2010, the firm had with approximately $9 billion in assets under management....
and Providence Equity Partners
Providence Equity Partners
Providence Equity Partners is a global private equity investment firm focused on media, entertainment, communications and information investments...
.
LBO bust (1990–1992)
By the end of the 1980s the excesses of the buyout market were beginning to show, with the bankruptcyBankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
of several large buyouts including Robert Campeau
Robert Campeau
Robert Campeau is a Canadian financier and real estate developer.-Early years:His formal education ended in grade eight, at the age of 14. He talked himself into jobs at Inco as a general labourer, carpenter and machinist. In 1949 he entered the residential end of the construction business...
's 1988 buyout of Federated Department Stores
Federated Department Stores
Macy's, Inc. is a department store holding company and owner of Macy's and Bloomingdale's department stores. Macy's Inc.'s stores specialize mostly in retail clothing, jewelery, watches, dinnerware, and furniture....
, the 1986 buyout of the Revco
Revco
Revco Discount Drug Stores , once based in Twinsburg, Ohio, was a major drug store chain operating through the Ohio Valley, the Mid-Atlantic states, and the Southeastern United States. The chain's stock was traded on the New York Stock Exchange under the ticker RXR...
drug stores, Walter Industries, FEB Trucking and Eaton Leonard. Additionally, the RJR Nabisco deal was showing signs of strain, leading to a recapitalization in 1990 that involved the contribution of $1.7 billion of new equity from KKR. Additionally, in response to the threat of unwelcome LBOs, certain companies adopted a number of techniques, such as the poison pill
Poison pill
A shareholder rights plan, colloquially known as a "poison pill", or simply "the pill" is a type of defensive tactic used by a corporation's board of directors against a takeover...
, to protect them against hostile takeovers by effectively self-destructing the company if it were to be taken over (these practices are increasingly discredited).
The collapse of Drexel Burnham Lambert
Drexel Burnham LambertDrexel Burnham Lambert
Drexel Burnham Lambert was a major Wall Street investment banking firm, which first rose to prominence and then was forced into bankruptcy in February 1990 by its involvement in illegal activities in the junk bond market, driven by Drexel employee Michael Milken. At its height, it was the...
was the investment bank most responsible for the boom in private equity during the 1980s due to its leadership in the issuance of high-yield debt
High-yield debt
In finance, a high-yield bond is a bond that is rated below investment grade...
. The firm was first rocked by scandal on May 12, 1986, when Dennis Levine
Dennis Levine
Dennis B. Levine was a prominent player in merger and acquisition business and the Wall Street insider trading scandals of the mid-1980s...
, a Drexel managing director and investment banker, was charged with insider trading
Insider trading
Insider trading is the trading of a corporation's stock or other securities by individuals with potential access to non-public information about the company...
. Levine pleaded guilty to four felonies, and implicated one of his recent partners, arbitrage
Arbitrage
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices...
ur Ivan Boesky
Ivan Boesky
Ivan Frederick Boesky is an American stock trader who is notable for his prominent role in a Wall Street insider trading scandal that occurred in the United States in the mid-1980s.-Life and career:...
. Largely based on information Boesky promised to provide about his dealings with Milken, the Securities and Exchange Commission initiated an investigation of Drexel on November 17. Two days later, Rudy Giuliani
Rudy Giuliani
Rudolph William Louis "Rudy" Giuliani KBE is an American lawyer, businessman, and politician from New York. He served as Mayor of New York City from 1994 to 2001....
, the United States Attorney for the Southern District of New York, launched his own investigation.
For two years, Drexel steadfastly denied any wrongdoing, claiming that the criminal and SEC cases were based almost entirely on the statements of an admitted felon
Felony
A felony is a serious crime in the common law countries. The term originates from English common law where felonies were originally crimes which involved the confiscation of a convicted person's land and goods; other crimes were called misdemeanors...
looking to reduce his sentence. However, it was not enough to keep the SEC from suing Drexel in September 1988 for insider trading, stock manipulation, defrauding its clients and stock parking (buying stocks for the benefit of another). All of the transactions involved Milken and his department. Giuliani began seriously considering indicting Drexel under the powerful Racketeer Influenced and Corrupt Organizations Act
Racketeer Influenced and Corrupt Organizations Act
The Racketeer Influenced and Corrupt Organizations Act, commonly referred to as the RICO Act or simply RICO, is a United States federal law that provides for extended criminal penalties and a civil cause of action for acts performed as part of an ongoing criminal organization...
(RICO), under the doctrine that companies are responsible for an employee's crimes.
The threat of a RICO indictment, which would have required the firm to put up a performance bond of as much as $1 billion in lieu of having its assets frozen, unnerved many at Drexel. Most of Drexel's capital was borrowed money, as is common with most investment banks and it is difficult to receive credit for firms under a RICO indictment. Drexel's CEO, Fred Joseph said that he had been told that if Drexel were indicted under RICO, it would only survive a month at most.
With literally minutes to go before being indicted, Drexel reached an agreement with the government in which it pleaded nolo contendere
Nolo contendere
is a legal term that comes from the Latin for "I do not wish to contend." It is also referred to as a plea of no contest.In criminal trials, and in some common law jurisdictions, it is a plea where the defendant neither admits nor disputes a charge, serving as an alternative to a pleading of...
(no contest) to six felonies – three counts of stock parking and three counts of stock manipulation. It also agreed to pay a fine of $650 million – at the time, the largest fine ever levied under securities laws. Milken left the firm after his own indictment in March 1989. Effectively, Drexel was now a convicted felon.
In April 1989, Drexel settled with the SEC, agreeing to stricter safeguards on its oversight procedures. Later that month, the firm eliminated 5,000 jobs by shuttering three departments – including the retail brokerage operation.
Meanwhile, the high-yield debt
High-yield debt
In finance, a high-yield bond is a bond that is rated below investment grade...
markets had begun to shut down in 1989, a slowdown that accelerated into 1990. On February 13, 1990 after being advised by United States Secretary of the Treasury
United States Secretary of the Treasury
The Secretary of the Treasury of the United States is the head of the United States Department of the Treasury, which is concerned with financial and monetary matters, and, until 2003, also with some issues of national security and defense. This position in the Federal Government of the United...
Nicholas F. Brady
Nicholas F. Brady
Nicholas Frederick Brady was United States Secretary of the Treasury under Presidents Ronald Reagan and George H. W. Bush, and is also known for articulating the Brady Plan in March 1989.-Early life:...
, the U.S. Securities and Exchange Commission (SEC), the New York Stock Exchange
New York Stock Exchange
The New York Stock Exchange is a stock exchange located at 11 Wall Street in Lower Manhattan, New York City, USA. It is by far the world's largest stock exchange by market capitalization of its listed companies at 13.39 trillion as of Dec 2010...
(NYSE) and the Federal Reserve System
Federal Reserve System
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...
, Drexel Burnham Lambert
Drexel Burnham Lambert
Drexel Burnham Lambert was a major Wall Street investment banking firm, which first rose to prominence and then was forced into bankruptcy in February 1990 by its involvement in illegal activities in the junk bond market, driven by Drexel employee Michael Milken. At its height, it was the...
officially filed for Chapter 11 bankruptcy protection.
S&L and the shutdown of the Junk Bond Market
In the 1980s, the boom in private equity transactions, specifically leveraged buyouts, was driven by the availability of financing, particularly high-yield debtHigh-yield debt
In finance, a high-yield bond is a bond that is rated below investment grade...
, also known as "junk bonds". The collapse of the high yield market in 1989 and 1990 would signal the end of the LBO boom. At that time, many market observers were pronouncing the junk bond market “finished.” This collapse would be due largely to three factors:
- The collapse of Drexel Burnham LambertDrexel Burnham LambertDrexel Burnham Lambert was a major Wall Street investment banking firm, which first rose to prominence and then was forced into bankruptcy in February 1990 by its involvement in illegal activities in the junk bond market, driven by Drexel employee Michael Milken. At its height, it was the...
, the foremost underwriter of junk bonds (discussed above).
- The dramatic increase in default rates among junk bond issuing companies. The historical default rate for high yield bonds from 1978 to 1988 was approximately 2.2% of total issuance. In 1989, defaults increased dramatically to 4.3% of the then $190 billion market and an additional 2.6% of issuance defaulted in the first half of 1990. As a result of the higher perceived risk, the differential in yieldYield (finance)In finance, the term yield describes the amount in cash that returns to the owners of a security. Normally it does not include the price variations, at the difference of the total return...
of the junk bond market over U.S. treasuriesTreasury securityA United States Treasury security is government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States federal government, and they are often referred to simply as Treasuries...
(known as the "spreadYield spreadIn finance, the yield spread is the difference between the quoted rates of return on two different investments, usually of different credit quality.It is a compound of yield and spread....
") had also increased by 700 basis pointBasis pointA basis point is a unit equal to 1/100 of a percentage point or one part per ten thousand...
s (7 percentage points). This made the cost of debt in the high yield market significantly more expensive than it had been previously. The market shut down altogether for lower rated issuers.
- The mandated withdrawal of savings and loans from the high yield market. In August 1989, the U.S. Congress enacted the Financial Institutions Reform, Recovery and Enforcement Act of 1989Financial Institutions Reform, Recovery and Enforcement Act of 1989The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 , , is a United States federal law enacted in the wake of the savings and loan crisis of the 1980s....
as a response to the savings and loan crisisSavings and Loan crisisThe savings and loan crisis of the 1980s and 1990s was the failure of about 747 out of the 3,234 savings and loan associations in the United States...
of the 1980s. Under the law, savings and loans (S&Ls) could no longer invest in bonds that were rated below investment grade. Additionally, S&Ls were mandated to sell their holdings by the end of 1993 creating a huge supply of low priced assets that helped freeze the new issuance market.
Despite the adverse market conditions, several of the largest private equity firms were founded in this period including: Apollo Management, Madison Dearborn
Madison Dearborn
Madison Dearborn Partners is a private equity firm specializing in leveraged buyouts of privately held or publicly traded companies, or divisions of larger companies; recapitalizations of family-owned or closely held companies; balance sheet restructurings; acquisition financings; and growth...
and
TPG Capital.
The second private equity boom and the origins of modern private equity
Beginning roughly in 1992, three years after the 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...
buyout, and continuing through the end of the decade the private equity industry once again experienced a tremendous boom, both in venture capital (as will be discussed below) and leveraged buyouts with the emergence of brand name firms managing multi-billion dollar sized funds. After declining from 1990 through 1992, the private equity industry began to increase in size raising approximately $20.8 billion of investor commitments in 1992 and reaching a high water mark in 2000 of $305.7 billion, outpacing the growth of almost every other asset class.
Resurgence of leveraged buyouts
Private equity in the 1980s was a controversial topic, commonly associated with corporate raidCorporate raid
A corporate raid is an American English business term for buying a large interest in a corporation and then using voting rights to enact measures directed at increasing the share value...
s, hostile takeovers, asset stripping
Asset stripping
Asset stripping involves selling the assets of a business individually at a profit. The term is generally used in a pejorative sense as such activity is not considered productive to the economy. Asset stripping is considered to be a problem in economies such as Russia or China that are making a...
, layoffs, plant closings and outsized profits to investors. As private equity reemerged in the 1990s it began to earn a new degree of legitimacy and respectability. Although in the 1980s, many of the acquisitions made were unsolicited and unwelcome, private equity firms in the 1990s focused on making buyouts attractive propositions for management and shareholders. According to The Economist
The Economist
The Economist is an English-language weekly news and international affairs publication owned by The Economist Newspaper Ltd. and edited in offices in the City of Westminster, London, England. Continuous publication began under founder James Wilson in September 1843...
, “[B]ig companies that would once have turned up their noses at an approach from a private-equity firm are now pleased to do business with them.” Additionally, private equity investors became increasingly focused on the long term development of companies they
acquired, using less leverage in the acquisition. In the 1980s leverage would routinely represent 85% to 95% of the purchase price of a company as compared to average debt levels between 20% and 40% in leveraged buyouts in the 1990s and the first decade of the 21st century. KKR's 1986 acquisition of Safeway, for example, was completed with 97% leverage and 3% equity contributed by KKR, whereas KKR's acquisition of TXU in 2007 was completed with approximately 19% equity contributed ($8.5 billion of equity out of a total purchase price of $45 billion). Additionally, private equity firms are more likely to make investments in capital expenditures and provide incentives for management to build long-term value.
The 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....
acquisition of Snapple Beverages, in 1992, is often described as the deal that marked the resurrection of the leveraged buyout after several dormant years. Only eight months after buying the company, Lee took Snapple Beverages public
Initial public offering
An initial public offering or stock market launch, is the first sale of stock by a private company to the public. It can be used by either small or large companies to raise expansion capital and become publicly traded enterprises...
and in 1994, only two years after the original acquisition, Lee sold the company to Quaker Oats for $1.7 billion. Lee was estimated to have made $900 million for himself and his investors from the sale. Quaker Oats would subsequently sell the company, which performed poorly under new management, three years later for only $300 million to Nelson Peltz's Triarc. As a result of the Snapple deal, Thomas H. Lee, who had begun investing in private equity in 1974, would find new prominence in the private equity industry and catapult his Boston-based
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....
to the ranks of the largest private equity firms.
It was also in this timeframe that the capital markets would start to open up again for private equity transactions. During the 1990–1993 period, Chemical Bank established its position as a key lender to private equity firms under the auspices of pioneering investment banker, James B. Lee, Jr.
James B. Lee, Jr.
James B. Lee Jr. , commonly known as Jimmy, is an investment banker, notable for his role in the development of the leveraged finance markets in the U.S. in the 1980s. Lee is widely credited as the architect of the modern-day syndicated loan market.Lee currently serves as vice chairman of JPMorgan...
(known as Jimmy Lee, not related to Thomas H. Lee). By the mid-1990s, under Jimmy Lee, Chemical had established itself as the largest lender in the financing of leveraged buyouts. Lee built a syndicated leveraged finance business and related advisory businesses including the first dedicated financial sponsor coverage group, which covered private equity firms in much the same way that investment banks had traditionally covered various industry sectors.
The following year, David Bonderman
David Bonderman
David Bonderman is a founding partner of TPG Capital and its Asian affiliate, Newbridge Capital...
and James Coulter
James Coulter (financier)
James Coulter is an American investment manager, and co-founder of private equity firm TPG Capital, originally known as the Texas Pacific Group.-Education:...
, who had worked for Robert M. Bass
Robert Bass
Robert Muse Bass is an American businessman and philanthropist. He is currently the chairman of Aerion Corporation, an American aerospace firm in Reno, Nevada. Bass is worth approximately $5.5 billion as of 2007, and $4 billion in 2010 on oil and other investments-Life:Bass was born into a wealthy...
during the 1980s completed a buyout of Continental Airlines
Continental Airlines
Continental Airlines was a major American airline now merged with United Airlines. On May 3, 2010, Continental Airlines, Inc. and UAL, Inc. announced a merger via a stock swap, and on October 1, 2010, the merger closed and UAL changed its name to United Continental Holdings, Inc...
in 1993, through their nascent Texas Pacific Group, (today TPG Capital). TPG was virtually alone in its conviction that there was an investment opportunity with the airline. The plan included bringing in a new management team, improving aircraft utilization and focusing on lucrative routes. By 1998, TPG had generated an annual internal rate of return of 55% on its investment. Unlike Carl Icahn
Carl Icahn
Carl Celian Icahn is an American business magnate and investor.-Biography:Icahn was raised in Far Rockaway, Queens, New York City, where he attended Far Rockaway High School. His father was a cantor, his mother was a schoolteacher...
's hostile takeover of TWA
Trans World Airlines
Trans World Airlines was an American airline that existed from 1925 until it was bought out by and merged with American Airlines in 2001. It was a major domestic airline in the United States and the main U.S.-based competitor of Pan American World Airways on intercontinental routes from 1946...
in 1985., Bonderman and Texas Pacific Group were widely hailed as saviors of the airline, marking the change in tone from the 1980s. The buyout of Continental Airlines
Continental Airlines
Continental Airlines was a major American airline now merged with United Airlines. On May 3, 2010, Continental Airlines, Inc. and UAL, Inc. announced a merger via a stock swap, and on October 1, 2010, the merger closed and UAL changed its name to United Continental Holdings, Inc...
would
be one of the few successes for the private equity industry which has suffered several major failures, including the 2008 bankruptcies of ATA Airlines
ATA Airlines
ATA Airlines, Inc., formerly known as American Trans Air, was an American low-cost scheduled service and charter airline based in Indianapolis, Indiana. ATA operated scheduled passenger flights throughout the US mainland and Hawaii, as well as military and commercial charter flights around the world...
, Aloha Airlines
Aloha Airlines
Aloha Airlines was an American airline headquartered in Honolulu CDP, City and County of Honolulu, Hawaii, operating from a hub at Honolulu International Airport...
and Eos Airlines
Eos Airlines
Eos Airlines, Inc. was an American all-business class airline headquartered in Purchase, New York, with its flights from John F. Kennedy International Airport, New York...
.
Among the most notable buyouts of the mid-to-late 1990s included: Duane Reade
Duane Reade
Duane Reade Inc., a subsidiary of the Walgreen Company, is a chain of pharmacy and convenience stores, primarily located in New York City, known for its high volume small store layouts in densely populated Manhattan locations...
(1990 (1997), Sealy Corporation
Sealy Corporation
Sealy Corporation is an American owned major manufacturer of mattresses, based in Trinity, North Carolina, in the United States. The company draws its name from the city where it started, Sealy, Texas.- History :...
(1997), KinderCare Learning Centers
KinderCare Learning Centers
KinderCare Learning Centers is an American operator of for-profit child care facilities founded in 1969. The company provides educational programs for children from six weeks to 12 years old...
(1997), J. Crew (1997), Domino's Pizza
Domino's Pizza
Domino's Pizza, Inc. is an international pizza delivery corporation headquartered in Ann Arbor, Michigan, United States of America. Founded in 1960, Domino's is the second-largest pizza chain in the United States and has over 9,000 corporate and franchised stores in 60 countries and all 50 U.S....
(1998), Regal Entertainment Group
Regal Entertainment Group
Regal Entertainment Group also known as REG is a movie theater chain headquartered in Knoxville, Tennessee. Regal operates the largest and most geographically diverse theater circuit in the United States, consisting of 6,775 screens in 548 locations in 39 states and the District of Columbia as of...
(1998), Oxford Health Plans
UnitedHealth Group
UnitedHealth Group Incorporated is a diversified health and "well-being" company. Headquartered in Minnetonka, Minnesota, UnitedHealth Group offers a spectrum of products and services through two operating businesses: United Healthcare and Optum. Through its family of subsidiaries and divisions,...
(1998) and Petco
PETCO
PETCO is a chain of retail stores that offers pet supplies and services such as grooming and dog training. Founded in 1965 and incorporated in Delaware, it is headquartered in San Diego, California...
(2000).
As the market for private equity matured, so too did its investor base. The Institutional Limited Partner Association was initially founded as an informal networking group for limited partner investors in 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....
s in the early 1990s. However the organization would evolve into an advocacy organization for private equity investors with more than 200 member organizations from 10 countries. As of the end of 2007, ILPA members had total assets under management in excess of $5 trillion with more than $850 billion of capital commitments to private equity investments.
The venture capital boom and the Internet Bubble (1995–2000)
In the 1980s, FedExFedEx
FedEx Corporation , originally known as FDX Corporation, is a logistics services company, based in the United States with headquarters in Memphis, Tennessee...
and Apple Inc. were able to grow because of private equity or venture funding, as were Cisco
Cisco
Cisco may refer to:Companies:*Cisco Systems, a computer networking company* Certis CISCO, corporatised entity of the former Commercial and Industrial Security Corporation in Singapore...
, Genentech
Genentech
Genentech 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...
, Microsoft
Microsoft
Microsoft Corporation is an American public multinational corporation headquartered in Redmond, Washington, USA that develops, manufactures, licenses, and supports a wide range of products and services predominantly related to computing through its various product divisions...
and Avis
Avis Rent A Car System
Avis Rent a Car System, LLC is a car rental company headquartered in Parsippany-Troy Hills Township, New Jersey, United States. Avis, Budget Rent a Car and Budget Truck Rental are all units of Avis Budget Group....
. However, by the end of the 1980s, venture capital returns were relatively low, particularly in comparison with their emerging leveraged buyout cousins, due in part to the competition for hot startups, excess supply of IPOs and the inexperience of many venture capital fund managers. Unlike the leveraged buyout industry, after total capital raised increased to $3 billion in 1983, growth in the venture capital industry remained limited through the 1980s and the first half of the 1990s increasing to just over $4 billion more than a decade later in 1994.
After a shakeout of venture capital managers, the more successful firms retrenched, focusing increasingly on improving operations at their portfolio companies rather than continuously making new investments. Results would begin to turn very attractive, successful and would ultimately generate the venture capital boom of the 1990s. Former Wharton Professor Andrew Metrick refers to these first 15 years of the modern venture capital industry beginning in 1980 as the "pre-boom period" in anticipation of the boom that would begin in 1995 and last through the bursting of the Internet bubble in 2000.
The late 1990s were a boom time for the venture capital, as 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...
in Menlo Park
Menlo Park, California
Menlo Park, California is a city at the eastern edge of San Mateo County, in the San Francisco Bay Area of California, in the United States. It is bordered by San Francisco Bay on the north and east; East Palo Alto, Palo Alto, and Stanford to the south; Atherton, North Fair Oaks, and Redwood City...
and Silicon Valley
Silicon Valley
Silicon Valley is a term which refers to the southern part of the San Francisco Bay Area in Northern California in the United States. The region is home to many of the world's largest technology corporations...
benefited from a huge surge of interest in the nascent Internet and other computer technologies. Initial public offerings of stock for technology and other growth companies were in abundance and venture firms were reaping large windfalls. Among the highest profile technology companies with venture capital backing were Amazon.com
Amazon.com
Amazon.com, Inc. is a multinational electronic commerce company headquartered in Seattle, Washington, United States. It is the world's largest online retailer. Amazon has separate websites for the following countries: United States, Canada, United Kingdom, Germany, France, Italy, Spain, Japan, and...
, America Online, E-bay, Intuit, Macromedia
Macromedia
Macromedia was an American graphics and web development software company headquartered in San Francisco, California that produced such products as Flash and Dreamweaver. Its rival, Adobe Systems, acquired Macromedia on December 3, 2005 and controls the line of Macromedia...
, Netscape
Netscape
Netscape Communications is a US computer services company, best known for Netscape Navigator, its web browser. When it was an independent company, its headquarters were in Mountain View, California...
, Sun Microsystems
Sun Microsystems
Sun Microsystems, Inc. was a company that sold :computers, computer components, :computer software, and :information technology services. Sun was founded on February 24, 1982...
and Yahoo!
Yahoo!
Yahoo! Inc. is an American multinational internet corporation headquartered in Sunnyvale, California, United States. The company is perhaps best known for its web portal, search engine , Yahoo! Directory, Yahoo! Mail, Yahoo! News, Yahoo! Groups, Yahoo! Answers, advertising, online mapping ,...
.
The bursting of the Internet Bubble and the private equity crash (2000–2003)
NASDAQ
The NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...
crash and technology slump that started in March 2000 shook virtually the entire venture capital industry as valuations for startup technology companies collapsed. Over the next two years, many venture firms had been forced to write-off large proportions of their investments and many funds were significantly "under water" (the values of the fund's investments were below the amount of capital invested). Venture capital investors sought to reduce size of commitments they had made to venture capital funds and in numerous instances, investors sought to unload existing commitments for cents on the dollar in the secondary market
Private equity secondary market
In 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....
. By mid-2003, the venture capital industry had shriveled to about half its 2001 capacity. Nevertheless, PricewaterhouseCoopers' MoneyTree Survey shows that total venture capital investments held steady at 2003 levels through the second quarter of 2005.
Although the post-boom years represent just a small fraction of the peak levels of venture investment reached in 2000, they still represent an increase over the levels of investment from 1980 through 1995. As a percentage of GDP, venture investment was 0.058% percent in 1994, peaked at 1.087% (nearly 19x the 1994 level) in 2000 and ranged from 0.164% to 0.182 % in 2003 and 2004. The revival of an Internet
Internet
The Internet is a global system of interconnected computer networks that use the standard Internet protocol suite to serve billions of users worldwide...
-driven environment (thanks to deals such as eBay
EBay
eBay Inc. is an American internet consumer-to-consumer corporation that manages eBay.com, an online auction and shopping website in which people and businesses buy and sell a broad variety of goods and services worldwide...
's purchase of Skype
Skype
Skype is a software application that allows users to make voice and video calls and chat over the Internet. Calls to other users within the Skype service are free, while calls to both traditional landline telephones and mobile phones can be made for a fee using a debit-based user account system...
, the News Corporation
News Corporation
News Corporation or News Corp. is an American multinational media conglomerate. It is the world's second-largest media conglomerate as of 2011 in terms of revenue, and the world's third largest in entertainment as of 2009, although the BBC remains the world's largest broadcaster...
's purchase of MySpace.com, and the very successful Google.com and Salesforce.com
Salesforce.com
Salesforce.com is an enterprise cloud computing company headquartered in San Francisco that distributes business software on a subscription basis. Salesforce.com hosts the applications off-site...
IPOs) have helped to revive the venture capital environment. However, as a percentage of the overall private equity market, venture capital has still not reached its mid-1990s level, let alone its peak in 2000.
Stagnation in the LBO market
Meanwhile, as the venture sector collapsed, the activity in the leveraged buyout market also declined significantly. Leveraged buyout firms had invested heavily in the telecommunications sector from 1996 to 2000 and profited from the boom which suddenly fizzled in 2001. In that year at least 27 major telecommunications companies, (i.e., with $100 million of liabilities or greater) filed for bankruptcy protection. Telecommunications, which made up a large portion of the overall high yield universe of issuers, dragged down the entire high yield market. Overall corporate default rates surged to levels unseen since the 1990 market collapse rising to 6.3% of high yield issuance in 2000 and 8.9% of issuance in 2001. Default rates on junk bonds peaked at 10.7 percent in January 2002 according to Moody'sMoody's
Moody's Corporation is the holding company for Moody's Analytics and Moody's Investors Service, a credit rating agency which performs international financial research and analysis on commercial and government entities. The company also ranks the credit-worthiness of borrowers using a standardized...
. As a result, leveraged buyout activity ground to a halt. The major collapses of former high-fliers including WorldCom, Adelphia Communications, Global Crossing
Global Crossing
Global Crossing Limited was a telecommunications company that provides computer networking services worldwide. It maintained a large backbone and offered transit and peering links, VPN, leased lines, audio and video conferencing, long distance telephone, managed services, dialup, colocation and...
and Winstar Communications
Winstar Communications
Winstar Communications is a former American telecommunications company that provided broadband services to business customers. Winstar owned and operated a broadband network in 60 major markets in the United States, including each of the top 30 U.S...
were among the most notable defaults in the market. In addition to the high rate of default, many investors lamented the low recovery rates achieved
through restructuring or bankruptcy.
Among the most affected by the bursting of the internet and telecom bubbles
Dot-com bubble
The dot-com bubble was a speculative bubble covering roughly 1995–2000 during which stock markets in industrialized nations saw their equity value rise rapidly from growth in the more...
were two of the largest and most active private equity firms of the 1990s: Tom Hicks
Tom Hicks
Thomas Ollis Hicks, Sr. , is an American 'leveraged buyout' businessman living in Dallas, Texas. Despite Forbes Magazine estimating Hicks' wealth at USD 1 billion in 2009, Hicks was unable to pay off joint loans of circa £200 million the following year...
' Hicks Muse Tate & Furst and Ted Forstmann's Forstmann Little & Company
Forstmann Little & Company
Forstmann, 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...
. These firms were often cited as the highest profile private equity casualties, having invested heavily in technology and telecommunications companies. Hicks Muse's reputation and market position were both damaged by the loss of over $1 billion from minority investments in six telecommunications and 13 Internet companies at the peak of the 1990s stock market bubble. Similarly, Forstmann suffered major losses from investments in McLeodUSA
McLeodUSA
McLeodUSA, based in Hiawatha, Iowa, is one of the nation’s largest independent competitive local exchange carriers . The company also has offices in Tulsa, Oklahoma, and The Woodlands, Texas....
and XO Communications
XO Communications
XO Communications is a telecommunications company owned by XO Holdings, Inc...
. Tom Hicks
Tom Hicks
Thomas Ollis Hicks, Sr. , is an American 'leveraged buyout' businessman living in Dallas, Texas. Despite Forbes Magazine estimating Hicks' wealth at USD 1 billion in 2009, Hicks was unable to pay off joint loans of circa £200 million the following year...
resigned from Hicks Muse at the end of 2004 and Forstmann Little was unable to raise a new fund. The treasure of the State of Connecticut, sued Forstmann Little to return the state's $96 million investment to that point
and to cancel the commitment it made to take its total investment to $200 million. The humbling of these private equity titans could hardly have been predicted by their investors in the 1990s and forced fund investors to conduct due diligence
Due diligence
"Due diligence" is a term used for a number of concepts involving either an investigation of a business or person prior to signing a contract, or an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations...
on fund managers more carefully and include greater controls on investments in partnership agreements.
Deals completed during this period tended to be smaller and financed less with high yield debt than in other periods. Private equity firms had to cobble together financing made up of bank loans and mezzanine debt, often with higher equity contributions than had been seen. Private equity firms benefited from the lower valuation multiples. As a result, despite the relatively limited activity, those funds that invested during the adverse market conditions delivered attractive returns to investors. Meanwhile, in Europe LBO activity began to increase as the market continued to mature. In 2001, for the first time, European buyout activity exceeded US activity with $44 billion of deals completed in Europe as compared with just $10.7 billion of deals completed in the US. This was a function of the fact that just six LBOs in excess of $500 million were completed in 2001, against 27 in 2000.
As investors sought to reduce their exposure to the private equity asset class, an area of private equity that was increasingly active in these years was the nascent secondary market
Private equity secondary market
In 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....
for private equity interests. Secondary transaction volume increased from historical levels of 2% or 3% of private equity commitments to 5% of the addressable market in the early years of the new decade. Many of the largest financial institutions (e.g., Deutsche Bank
Deutsche Bank
Deutsche Bank AG is a global financial service company with its headquarters in Frankfurt, Germany. It employs more than 100,000 people in over 70 countries, and has a large presence in Europe, the Americas, Asia Pacific and the emerging markets...
, Abbey National
Abbey National
Abbey National plc was a UK-based bank and former building society, which latterly traded under the Abbey brand name. It became a wholly owned subsidiary of Grupo Santander of Spain in 2004, and was rebranded as Santander in January 2010, forming Santander UK along with the savings business of the...
, UBS AG
UBS AG
UBS AG is a Swiss global financial services company headquartered in Basel and Zürich, Switzerland, which provides investment banking, asset management, and wealth management services for private, corporate, and institutional clients worldwide, as well as retail clients in Switzerland...
) sold portfolios of direct investments and “pay-to-play” funds portfolios that were typically used as a means to gain entry to lucrative leveraged finance
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
and mergers and
acquisitions assignments but had created hundreds of millions of dollars of losses. Some of the most notable financial institutions to complete publicly disclosed secondary transactions during this period include: Chase Capital Partners
Chase (bank)
JPMorgan Chase Bank, N.A., doing business as Chase, is a national bank that constitutes the consumer and commercial banking subsidiary of financial services firm JPMorgan Chase. The bank was known as Chase Manhattan Bank until it merged with J.P. Morgan & Co. in 2000...
(2000), National Westminster Bank
National Westminster Bank
National Westminster Bank Plc, commonly known as NatWest, is the largest retail and commercial bank in the United Kingdom and has been part of The Royal Bank of Scotland Group Plc since 2000. The Royal Bank of Scotland Group is ranked as the second largest bank in the world by assets...
(2000), UBS AG
UBS AG
UBS AG is a Swiss global financial services company headquartered in Basel and Zürich, Switzerland, which provides investment banking, asset management, and wealth management services for private, corporate, and institutional clients worldwide, as well as retail clients in Switzerland...
(2003), Deutsche Bank
Deutsche Bank
Deutsche Bank AG is a global financial service company with its headquarters in Frankfurt, Germany. It employs more than 100,000 people in over 70 countries, and has a large presence in Europe, the Americas, Asia Pacific and the emerging markets...
(MidOcean Partners
MidOcean Partners
MidOcean Partners is a private equity firm specializing in leveraged buyouts, recapitalizations and growth capital investments in middle-market companies...
) (2003) Abbey National
Abbey National
Abbey National plc was a UK-based bank and former building society, which latterly traded under the Abbey brand name. It became a wholly owned subsidiary of Grupo Santander of Spain in 2004, and was rebranded as Santander in January 2010, forming Santander UK along with the savings business of the...
(2004) and Bank One (2004).
The third private equity boom and the Golden Age of Private Equity (2003–2007)
As 2002 ended and 2003 began, the private equity sector, had spent the previous three two and a half years reeling from major losses in telecommunications and technology companies and had been severely constrained by tight credit markets. As 2003 got underway, private equity began a five year resurgence that would ultimately result in the completion of 13 of the 15 largest leveraged buyout transactions in history, unprecedented levels of investment activity and investor commitments and a major expansion and maturation of the leading private equity firmPrivate equity firm
A 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...
s.
The combination of decreasing interest rates, loosening lending standards and regulatory changes for publicly traded companies would set the stage for the largest boom private equity had seen. The Sarbanes Oxley
Sarbanes-Oxley Act
The Sarbanes–Oxley Act of 2002 , also known as the 'Public Company Accounting Reform and Investor Protection Act' and 'Corporate and Auditing Accountability and Responsibility Act' and commonly called Sarbanes–Oxley, Sarbox or SOX, is a United States federal law enacted on July 30, 2002, which...
legislation, officially the Public Company Accounting Reform and Investor Protection Act, passed in 2002, in the wake of corporate scandals at Enron
Enron
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. Before its bankruptcy on December 2, 2001, Enron employed approximately 22,000 staff and was one of the world's leading electricity, natural gas, communications, and pulp and paper companies, with...
, WorldCom, Tyco
Tyco International
Tyco International Ltd. is a highly diversified global manufacturing company incorporated in Switzerland, with United States operational headquarters in Princeton, New Jersey...
, Adelphia, Peregrine Systems
Peregrine Systems
Peregrine Systems, Inc., an enterprise software company, was founded in 1981 and sold enterprise asset management, change management, and ITIL-based IT service management software. Following an accounting scandal and bankruptcy in 2003, Peregrine was acquired by Hewlett-Packard in 2005...
and Global Crossing
Global Crossing
Global Crossing Limited was a telecommunications company that provides computer networking services worldwide. It maintained a large backbone and offered transit and peering links, VPN, leased lines, audio and video conferencing, long distance telephone, managed services, dialup, colocation and...
among others, would create a new regime of rules and regulations for publicly traded corporations. In addition to the existing focus on short term earnings rather than long term value creation, many public company executives lamented the extra cost and bureaucracy associated with Sarbanes-Oxley
Sarbanes-Oxley Act
The Sarbanes–Oxley Act of 2002 , also known as the 'Public Company Accounting Reform and Investor Protection Act' and 'Corporate and Auditing Accountability and Responsibility Act' and commonly called Sarbanes–Oxley, Sarbox or SOX, is a United States federal law enacted on July 30, 2002, which...
compliance. For the first time, many large corporations saw private equity ownership as potentially more attractive than remaining public. Sarbanes-Oxley would have the opposite effect on the venture capital industry. The
increased compliance costs would make it nearly impossible for venture capitalists to bring young companies to the public markets and dramatically reduced the opportunities for exits via IPO. Instead, venture capitalists have been forced increasingly to rely on sales to strategic buyers for an exit of their investment.
Interest rates, which began a major series of decreases in 2002 would reduce the cost of borrowing and increase the ability of private equity firms to finance large acquisitions. Lower interest rates would encourage investors to return to relatively dormant high-yield debt
High-yield debt
In finance, a high-yield bond is a bond that is rated below investment grade...
and leveraged loan
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
markets, making debt more readily available to finance buyouts. Additionally, alternative investments also became increasingly important as investors focused on yields despite increases in risk. This search for higher yielding investments would fuel larger funds, allowing larger deals, never before thought possible, to become reality.
Certain buyouts were completed in 2001 and early 2002, particularly in Europe where financing was more readily available. In 2001, for example, BT Group
BT Group
BT Group plc is a global telecommunications services company headquartered in London, United Kingdom. It is one of the largest telecommunications services companies in the world and has operations in more than 170 countries. Through its BT Global Services division it is a major supplier of...
agreed to sell its international yellow pages directories business (Yell Group
Yell Group
Yell Group plc is a multinational directories company headquartered in Reading, United Kingdom. As well as the United Kingdom, it has operations in the United States, Spain and some countries in Latin America...
) to Apax Partners
Apax Partners
Apax 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...
and Hicks, Muse, Tate & Furst for £2.14 billion (approximately $3.5 billion at the time), making it then the largest non-corporate LBO in European history. Yell later bought US directories publisher McLeodUSA for about $600 million, and floated on London's FTSE
FTSE 100 Index
The FTSE 100 Index, also called FTSE 100, FTSE, or, informally, the footsie , is a share index of the 100 most highly capitalised UK companies listed on the London Stock Exchange....
in 2003.
Resurgence of the large buyout
Marked by the two-stage buyout of Dex MediaDex Media
Dex Media, Inc. was a print and interactive marketing company. It was acquired by R.H. Donnelley, which became Dex One Corporation in February 2010...
at the end of 2002 and 2003, large multi-billion dollar U.S. buyouts could once again obtain significant high yield debt financing and larger transactions could be completed. The Carlyle Group, Welsh, Carson, Anderson & Stowe
Welsh, Carson, Anderson & Stowe
Welsh, 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...
, along with other private investors, led a $7.5 billion buyout of QwestDex. The buyout was the third largest corporate buyout since 1989. QwestDex's purchase occurred in two stages: a $2.75 billion acquisition of assets known as Dex Media East in November 2002 and a $4.30 billion acquisition of assets known as Dex Media West in 2003. R. H. Donnelley Corporation acquired Dex Media in 2006. Shortly after Dex Media, other larger buyouts would be completed signaling the resurgence in private equity was underway. The acquisitions included Burger King
Burger King
Burger King, often abbreviated as BK, is a global chain of hamburger fast food restaurants headquartered in unincorporated Miami-Dade County, Florida, United States. The company began in 1953 as Insta-Burger King, a Jacksonville, Florida-based restaurant chain...
(by Bain Capital
Bain Capital
Bain Capital LLC is a Boston-based private equity firm founded in 1984 by partners from the consulting firm Bain & Company. Originally conceived as an early-stage, growth-oriented investment fund, Bain Capital today manages approximately $65 billion in assets, and its strategies include private...
), Jefferson Smurfit (by Madison Dearborn
Madison Dearborn
Madison Dearborn Partners is a private equity firm specializing in leveraged buyouts of privately held or publicly traded companies, or divisions of larger companies; recapitalizations of family-owned or closely held companies; balance sheet restructurings; acquisition financings; and growth...
), Houghton Mifflin
Houghton Mifflin
Houghton Mifflin Harcourt is an educational and trade publisher in the United States. Headquartered in Boston's Back Bay, it publishes textbooks, instructional technology materials, assessments, reference works, and fiction and non-fiction for both young readers and adults.-History:The company was...
(by Bain Capital
Bain Capital
Bain Capital LLC is a Boston-based private equity firm founded in 1984 by partners from the consulting firm Bain & Company. Originally conceived as an early-stage, growth-oriented investment fund, Bain Capital today manages approximately $65 billion in assets, and its strategies include private...
, the Blackstone Group and 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....
) and TRW Automotive
TRW Automotive
TRW Automotive , headquartered in Livonia, Michigan, USA, is a major global supplier of automotive systems, modules and components to automotive original equipment manufacturers and related aftermarkets....
by the Blackstone Group
Blackstone Group
The Blackstone Group L.P. is an American-based alternative asset management and financial services company that specializes in private equity, real estate, and credit and marketable alternative investment strategies, as well as financial advisory services, such as mergers and acquisitions ,...
.
In 2006 USA Today reported retrospectively on the revival of private equity:
- LBOs are back, only they've rebranded themselves private equity and vow a happier ending. The firms say this time it's completely different. Instead of buying companies and dismantling them, as was their rap in the '80s, private equity firms… squeeze more profit out of underperforming companies.
- But whether today's private equity firms are simply a regurgitation of their counterparts in the 1980s… or a kinder, gentler version, one thing remains clear: private equity is now enjoying a "Golden Age." And with returns that triple the S&P 500, it's no wonder they are challenging the public markets for supremacy.
By 2004 and 2005, major buyouts were once again becoming common and market observers were stunned by the leverage levels and financing terms obtained by financial sponsor
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....
s in their buyouts. Some of the notable buyouts of this period include: Dollarama
Dollarama
Dollarama is a chain of over 690 dollar stores across Canada. The company is headquartered in Montreal and, since 2009, is Canada's largest retailer of items for 2 dollars or less. The first Dollarama store was created at the shopping centre "Les promenades du St-Laurent" in Matane...
(2004), Toys "R" Us (2004), The Hertz Corporation
The Hertz Corporation
Hertz Global Holdings Inc is an American car rental company with international locations in 145 countries worldwide.-Early years:The company was founded by Walter L. Jacobs in 1918, who started a car rental operation in Chicago with a dozen Model T Ford cars. In 1923, Jacobs sold it to John D...
(2005), Metro-Goldwyn-Mayer
Metro-Goldwyn-Mayer
Metro-Goldwyn-Mayer Inc. is an American media company, involved primarily in the production and distribution of films and television programs. MGM was founded in 1924 when the entertainment entrepreneur Marcus Loew gained control of Metro Pictures, Goldwyn Pictures Corporation and Louis B. Mayer...
(2005) and SunGard
SunGard
SunGard is a multinational company based in Wayne, Pennsylvania, which provides software and services to education, financial services, and public sector organizations. It was formed in 1983, as a spin-off of the computer services division of Sun Oil Company, during a period of low crude oil...
(2005).
Age of the mega-buyout
Dot-com bubble
The dot-com bubble was a speculative bubble covering roughly 1995–2000 during which stock markets in industrialized nations saw their equity value rise rapidly from growth in the more...
), raised only $25.1 billion in 2006, a 2% percent decline from 2005 and a significant decline from its peak. The following year, despite the onset of turmoil in the credit markets in the summer, saw yet another record year of fundraising with $302 billion of investor commitments to 415 funds.
Among the largest buyouts of this period included: Georgia-Pacific Corp (2005), Albertson's
Albertsons LLC
Albertsons LLC is a North American grocery company based in Boise, Idaho, with over 240 supermarkets located in Arizona, New Mexico, Colorado, Texas, Louisiana, Arkansas, and Florida under the Albertson's and Super Saver Foods banners...
(2006), Equity Office Properties (2006 ), Freescale Semiconductor
Freescale Semiconductor
Freescale Semiconductor, Inc. is a producer and designer of embedded hardware, with 17 billion semiconductor chips in use around the world. The company focuses on the automotive, consumer, industrial and networking markets with its product portfolio including microprocessors, microcontrollers,...
(2006), GMAC (2006), HCA
Hospital Corporation of America
Hospital Corporation of America is the largest private operator of health care facilities in the world, It is based in Nashville, Tennessee and is widely considered to be the single largest factor in making that city a hotspot for healthcare enterprise.-History:The founders of HCA include Jack C....
(2006), Kinder Morgan
Kinder Morgan
Kinder Morgan, Inc. is an American energy company. It is also, through a subsidiary, the general partner of and owner of many of the interests in Kinder Morgan Energy Partners, a publicly traded pipeline and terminal limited partnership....
(2006), Harrah's Entertainment
Harrah's Entertainment
Caesars Entertainment Corporation is a private gaming corporation that owns and operates over 50 casinos, hotels, and seven golf courses under several brands. The company, based in Paradise, Nevada, is the largest gaming company in the world, with yearly revenues $8.9 billion...
(2006), TDC A/S
TDC A/S
TDC A/S is the former telecom monopoly in Denmark. It is now privatized. Thus, it is the biggest company in all aspects of telecommunications in Denmark with landline, mobile, Internet, VHF maritime borderline-radio etc.By the end of 2004, the TDC Group had more than 13.4 mil. customers in Europe:...
(2006), Sabre Holdings
Sabre Holdings
Sabre Holdings or Sabre, Inc. is an American privately held travel technology company, encompassing several brands in three global distribution system channels: travel agency, airline, and direct to consumer. These areas are serviced by TSG's three main business groups...
(2006), Travelport
Travelport
Travelport is a broad-based business services company and a leading provider of critical transaction processing solutions to companies operating in the global travel industry...
(2006), Alliance Boots
Alliance Boots
Alliance Boots GmbH is a leading international, pharmacy-led health and beauty group. It has two core business activities - pharmacy-led health and beauty retailing, and pharmaceutical wholesaling and distribution - and has a presence in more than 25 countries...
(2007), Biomet
Biomet
Biomet, Inc. is one of the world leading medical device manufacturer located in the Warsaw, Indiana business cluster. The company specializes in reconstructive products for hips, knees and shoulders, fixation devices, orthopedic support devices, dental implants, spinal implants and operating room...
(2007), Chrysler
Chrysler
Chrysler Group LLC is a multinational automaker headquartered in Auburn Hills, Michigan, USA. Chrysler was first organized as the Chrysler Corporation in 1925....
(2007), First Data
First Data
First Data Corporation is an American payment processing company headquartered in Atlanta, Georgia. First Data is a provider of electronic commerce and payment solutions...
(2007) and TXU
TXU
Energy Future Holdings Corporation is an electric utility company headquartered in Energy Plaza in Downtown Dallas, Texas, United States. The company was known as TXU until its $45 billion leveraged buyout by Kohlberg Kravis Roberts, Texas Pacific Group and Goldman Sachs...
(2007).
Publicly traded private equity
Although there had previously been certain instances of publicly traded private equity vehicles, the convergence of private equity and the public equity marketsStock 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...
attracted significantly greater attention when several of the largest private equity firms pursued various options through the public markets. Taking private equity firms and private equity funds public appeared an unusual move since private equity funds often buy public companies listed on exchange and then take them private. Private equity firms are rarely subject to the quarterly reporting requirements of the public markets and tout this independence to prospective sellers as a key advantage of going private. Nevertheless, there are fundamentally two separate opportunities that private equity firms pursued in the public markets. These options involved a public listing of either:
- A 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...
(the management company), which provides shareholders an opportunity to gain exposure to the management feeManagement feeIn the investment advisory industry, a management fee is a periodic payment that is paid by investors in a pooled investment fund to the fund's investment adviser for investment and portfolio management services.-Mutual funds:...
s and carried interestCarried interestCarried 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...
earned by the investment professionals and managers of the private equity firm. The most notable example of this public listing was completed by The Blackstone GroupBlackstone GroupThe Blackstone Group L.P. is an American-based alternative asset management and financial services company that specializes in private equity, real estate, and credit and marketable alternative investment strategies, as well as financial advisory services, such as mergers and acquisitions ,...
in 2007
- A 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....
or similar investment vehicle, which allows investors that would otherwise be unable to invest in a traditional private equity limited partnershipLimited partnershipA 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,...
to gain exposure to a portfolio of private equity investments.
In May 2006, Kohlberg Kravis Roberts raised $5 billion in an initial public offering for a new permanent investment vehicle (KKR Private Equity Investors or KPE) listing it on the Euronext
Euronext
Euronext N.V. is a pan-European stock exchange based in Amsterdam and with subsidiaries in Belgium, France, Netherlands, Portugal and the United Kingdom. In addition to equities and derivatives markets, the Euronext group provides clearing and information services...
exchange in Amsterdam
Amsterdam
Amsterdam is the largest city and the capital of the Netherlands. The current position of Amsterdam as capital city of the Kingdom of the Netherlands is governed by the constitution of August 24, 1815 and its successors. Amsterdam has a population of 783,364 within city limits, an urban population...
(ENXTAM: KPE). KKR raised more than three times what it had expected at the outset as many of the investors in KPE were hedge funds seeking exposure to private equity but could not make long term commitments to private equity funds. Because private equity had been booming in the preceding years, the proposition of investing in a KKR fund appeared attractive to certain investors.
KPE's first-day performance was lackluster, trading down 1.7% and trading volume was limited. Initially, a handful of other private equity firms, including Blackstone, and hedge funds had planned to follow KKR's lead but when KPE was increased to $5 billion, it soaked up all the demand. That together with the slump of KPE's shares caused the other firms shelved their plans. KPE's stock declined from an IPO price of €25 per share to €18.16 (a 27% decline) at the end of 2007 and a low of €11.45 (a 54.2% decline) per share in Q1 2008. KPE disclosed in May 2008 that it had completed approximately $300 million of secondary sales
Private equity secondary market
In 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....
of selected limited
partnership interests in and undrawn commitments to certain KKR-managed funds in order to generate liquidity and repay borrowings.
Less than two weeks after the Blackstone Group IPO, rival firm Kohlberg Kravis Roberts filed with the SEC in July 2007 to raise $1.25 billion by selling an ownership interest in its management company. KKR had previously listed its KKR Private Equity Investors (KPE) private equity fund vehicle in 2006. The onset of the credit crunch and the shutdown of the IPO market would dampen the prospects of obtaining a valuation that would be attractive to KKR and the flotation was repeatedly postponed.
Meanwhile, other private equity investors were seeking to realize a portion of the value locked into their firms. In September 2007, the Carlyle Group
Carlyle Group
The Carlyle Group is an American-based global asset management firm, specializing in private equity, based in Washington, D.C. The Carlyle Group operates in four business areas: corporate private equity, real assets, market strategies and fund-of-funds, through its AlpInvest subsidiary...
sold a 7.5% interest in its management company to Mubadala Development Company, which is owned by the Abu Dhabi Investment Authority
Abu Dhabi Investment Authority
The Abu Dhabi Investment Authority is a sovereign wealth fund owned by Abu Dhabi, United Arab Emirates founded for the purpose of investing funds on behalf of the Government of Abu Dhabi....
(ADIA) for $1.35 billion, which valued Carlyle at approximately $20 billion. Similarly, in January 2008, Silver Lake Partners
Silver Lake Partners
Silver Lake is a US-based private equity firm focused on leveraged buyout and growth capital investments in technology, technology-enabled and related industries...
sold a 9.9% stake in its management company to the California Public Employees' Retirement System (CalPERS)
CalPERS
The California Public Employees' Retirement System or CalPERS is an agency in the California executive branch that "manages pension and health benefits for more than 1.6 million California public employees, retirees, and their families"...
for $275 million.
Additionally, Apollo Management completed a private placement of shares in its management company in July 2007. By pursuing a private placement rather than a public offering, Apollo would be able to avoid much of the public scrutiny applied to Blackstone and KKR. In April 2008, Apollo filed with the SEC to permit some holders of its privately traded stock to sell their shares on the New York Stock Exchange
New York Stock Exchange
The New York Stock Exchange is a stock exchange located at 11 Wall Street in Lower Manhattan, New York City, USA. It is by far the world's largest stock exchange by market capitalization of its listed companies at 13.39 trillion as of Dec 2010...
. In April 2004, Apollo raised $930 million for a listed business development company
Business Development Company
A Business Development Company is a form of publicly traded private equity in the United States created by Congress in 1980 as amendments to the Investment Company Act of 1940...
, Apollo Investment Corporation (NASDAQ: AINV), to invest primarily in middle-market companies in the form of mezzanine debt and senior secured loans
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
, as well as by making direct equity investments in
companies. The Company also invests in the securities of public companies.
Historically, in the United States, there had been a group of publicly traded private equity firms that were registered as business development companies (BDCs) under the Investment Company Act of 1940
Investment Company Act of 1940
The Investment Company Act of 1940 is an act of Congress. It was passed as a United States Public Law on August 22, 1940, and is codified at through . Along with the Securities Exchange Act of 1934 and Investment Advisers Act of 1940, and extensive rules issued by the Securities and Exchange...
. Typically, BDCs are structured similar to real estate investment trust
Real estate investment trust
A real estate investment trust or REIT is a tax designation for a corporate entity investing in real estate. The purpose of this designation is to reduce or eliminate corporate tax. In return, REITs are required to distribute 90% of their taxable income into the hands of investors...
s (REITs) in that the BDC structure reduces or eliminates corporate income tax. In return, REITs are required to distribute
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...
90% of their income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
, which may be taxable to its investor
Investor
An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
s. As of the end of 2007, among the largest BDCs (by market value, excluding Apollo Investment Corp, discussed earlier) are: American Capital Strategies
American Capital Strategies
American Capital is an alternative asset management company based in Bethesda, Maryland. Founded in 1986 and publicly traded since 1997, American Capital is the largest U.S. publicly traded private equity fund and one of the largest publicly traded alternative asset managers...
(NASDAQ: ACAS), Allied Capital Corp((NASDAQ:ALD), Ares Capital Corporation (NASDAQ:ARCC),
Gladstone Investment Corp (NASDAQ:GAIN) and Kohlberg Capital Corp
Kohlberg & Company
Kohlberg & Company is a private equity firm that focuses on leveraged buyout transactions founded by industry pioneer Jerome Kohlberg, Jr.Today, the firm invests in a variety of transactions including leveraged carveouts , take private transactions and acquisitions of privately held companies...
(NASDAQ:KCAP).
Secondary market and the evolution of the private equity asset class
In the wake of the collapse of the equity markets in 2000, many investors in private equity sought an early exit from their outstanding commitments. The surge in activity in the secondary market, which had previously been a relatively small niche of the private equity industry, prompted new entrants to the market, however the market was still characterized by limited liquidity and distressed prices with private equity funds trading at significant discounts to fair value.Beginning in 2004 and extending through 2007, the secondary market transformed into a more efficient market in which assets for the first time traded at or above their estimated fair values and liquidity increased dramatically. During these years, the secondary market transitioned from a niche sub-category in which the majority of sellers were distressed to an active market with ample supply of assets and numerous market participants. By 2006 active portfolio management had become far more common in the increasingly developed secondary market and an increasing number of investors had begun to pursue secondary sales to rebalance their private equity portfolios. The continued evolution of the private equity secondary market reflected the maturation and evolution of the larger private equity industry. Among the most notable publicly disclosed secondary transactions
(it is estimated that over two-thirds of secondary market activity is never disclosed publicly): CalPERS (2008), Ohio Bureau of Workers' Compensation
Ohio Bureau of Workers' Compensation
The Ohio Bureau of Workers' Compensation provides workers' compensation insurance coverage for employers and employees in the State of Ohio through a $22 billion fund...
(2007), MetLife (2007), Bank of America
Bank of America
Bank of America Corporation, an American multinational banking and financial services corporation, is the second largest bank holding company in the United States by assets, and the fourth largest bank in the U.S. by market capitalization. The bank is headquartered in Charlotte, North Carolina...
(2006 and 2007), Mellon Financial Corporation (2006), American Capital Strategies
American Capital Strategies
American Capital is an alternative asset management company based in Bethesda, Maryland. Founded in 1986 and publicly traded since 1997, American Capital is the largest U.S. publicly traded private equity fund and one of the largest publicly traded alternative asset managers...
(2006), JPMorgan Chase, Temasek Holdings
Temasek Holdings
Temasek Holdings is an investment company owned by the government of Singapore. With an international staff of 380 people, it manages a portfolio of about S$193 billion at end of March 2011, focused primarily in Asia...
, Dresdner Bank
Dresdner Bank
Dresdner Bank AG was one of Germany's largest banking corporations and was based in Frankfurt. It was acquired by competitor Commerzbank in December 2009.- 19th century :...
and Dayton Power & Light.
The Credit Crunch and post-modern private equity (2007–2008)
In July 2007, turmoil that had been affecting the mortgage marketsSubprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
, spilled over into the leveraged finance
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
and high-yield debt
High-yield debt
In finance, a high-yield bond is a bond that is rated below investment grade...
markets. The markets had been highly robust during the first six months of 2007, with highly issuer friendly developments including PIK and PIK Toggle
PIK loan
A PIK loan is a type of loan which typically does not provide for any cash flows from borrower to lender between the drawdown date and the maturity or refinancing date, not even interest or parts thereof , thus making it an expensive, high-risk financing instrument...
(interest is "Payable In Kind") and covenant light
Cov-lite
Cov-lite is financial jargon for loan agreements which do not contain the usual protective covenants for the benefit of the lending party...
debt widely available to finance large leveraged buyouts. July and August saw a notable slowdown in issuance levels in the high yield and leveraged loan markets with only few issuers accessing the market. Uncertain market
conditions led to a significant widening of yield spreads, which coupled with the typical summer slowdown led to many companies and investment banks to put their plans to issue debt on hold until the autumn. However, the expected rebound in the market after Labor Day
Labor Day
Labor Day is a United States federal holiday observed on the first Monday in September that celebrates the economic and social contributions of workers.-History:...
2007 did not materialize and the lack of market confidence prevented deals from pricing. By the end of September, the full extent of the credit situation became obvious as major lenders including Citigroup
Citigroup
Citigroup Inc. or Citi is an American multinational financial services corporation headquartered in Manhattan, New York City, New York, United States. Citigroup was formed from one of the world's largest mergers in history by combining the banking giant Citicorp and financial conglomerate...
and UBS AG
UBS AG
UBS AG is a Swiss global financial services company headquartered in Basel and Zürich, Switzerland, which provides investment banking, asset management, and wealth management services for private, corporate, and institutional clients worldwide, as well as retail clients in Switzerland...
announced major writedowns due to credit losses. The leveraged finance markets came to a near standstill. As a result of the sudden change in the market, buyers would begin to withdraw from or renegotiate the deals completed at the top of the market, most notably in transactions involving: Harman International (announced and withdrawn 2007), Sallie Mae (announced 2007 but
withdrawn 2008), Clear Channel Communications
Clear Channel Communications
Clear Channel Communications, Inc. is an American media conglomerate company headquartered in San Antonio, Texas. It was founded in 1972 by Lowry Mays and Red McCombs, and was taken private by Bain Capital LLC and Thomas H. Lee Partners LP in a leveraged buyout in 2008...
(2007) and BCE
Bell Canada
Bell Canada is a major Canadian telecommunications company. Including its subsidiaries such as Bell Aliant, Northwestel, Télébec, and NorthernTel, it is the incumbent local exchange carrier for telephone and DSL Internet services in most of Canada east of Manitoba and in the northern territories,...
(2007).
Additionally, the credit crunch has prompted buyout firms to pursue a new group of transactions in order to deploy their massive investment funds. These transactions have included Private Investment in Public Equity
Private investment in public equity
A 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...
(or PIPE) transactions as well as purchases of debt in existing leveraged buyout transactions. Some of the most notable of these transactions completed in the depths of the credit crunch include Apollo Management's acquisition of the Citigroup
Citigroup
Citigroup Inc. or Citi is an American multinational financial services corporation headquartered in Manhattan, New York City, New York, United States. Citigroup was formed from one of the world's largest mergers in history by combining the banking giant Citicorp and financial conglomerate...
Loan Portfolio (2008) and TPG Capital's PIPE
Private investment in public equity
A 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...
investment in Washington Mutual
Washington Mutual
Washington Mutual, Inc. , abbreviated to WaMu, was a savings bank holding company and the former owner of Washington Mutual Bank, which was the United States' largest savings and loan association until its collapse in 2008....
(2008). According to investors and fund managers, the consensus among industry members in late 2009 was that private equity firms will need to become more like asset managers, offering buyouts as just part of their portfolio, or else focus tightly on specific sectors in order to prosper. The industry must also become better in adding value by turning businesses around rather than pure financial engineering.
1980s reflections of private equity
Although private equity rarely received a thorough treatment in popular culture, several films did feature stereotypical "corporate raiders" prominently. Among the most notable examples of private equity featured in motion pictures included:- Wall Street (1987) – The notorious "corporate raider" and "greenmailer" Gordon GekkoGordon GekkoGordon Gekko is the main antagonist of the 1987 film Wall Street and the antihero of the 2010 film Wall Street: Money Never Sleeps, both by director Oliver Stone...
, representing a synthesis of the worst features of various famous private equity figures, intends to manipulate an ambitious young stockbroker to take over a failing but decent airline. Although Gekko makes a pretense of caring about the airline, his intentions prove to be to destroy the airline, strip its assets and lay off its employees before raiding the corporate pension fundPension fundA pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
. Gekko would become a symbol in popular culture for unrestrained greed (with the signature line, "Greed, for lack of a better word, is good") that would be attached to the private equity industry. - Other People's MoneyOther People's MoneyOther People's Money is a 1991 drama/romantic comedy film starring Danny DeVito, Penelope Ann Miller and Gregory Peck. It is based on the play of the same name by Jerry Sterner. The director was Norman Jewison and the screenplay was credited to Alvin Sargent.-Plot:Corporate raider Lawrence...
(1991) – A self-absorbed corporate raider "Larry the Liquidator" (Danny DeVitoDanny DeVitoDaniel Michael DeVito, Jr. , better known as Danny DeVito, is an American actor, comedian, director and producer. He first gained prominence for his portrayal of Louie De Palma on the ABC and NBC television series Taxi , for which he won a Golden Globe and an Emmy.DeVito and his wife, Rhea Perlman,...
), sets his sights on New England Wire and Cable, a small-town business run by family patriarch Gregory PeckGregory PeckEldred Gregory Peck was an American actor.One of 20th Century Fox's most popular film stars from the 1940s to the 1960s, Peck continued to play important roles well into the 1980s. His notable performances include that of Atticus Finch in the 1962 film To Kill a Mockingbird, for which he won an...
who is principally interested in protecting his employees and the town. - Pretty WomanPretty WomanPretty Woman is a 1990 romantic comedy film set in Los Angeles, California. Written by J.F. Lawton and directed by Garry Marshall, this motion picture features Richard Gere and Julia Roberts, and also Hector Elizondo, Ralph Bellamy, and Jason Alexander in supporting roles. Roberts played the only...
(1990) – Although Richard GereRichard GereRichard Tiffany Gere is an American actor. He began acting in the 1970s, playing a supporting role in Looking for Mr. Goodbar, and a starring role in Days of Heaven. He came to prominence in 1980 for his role in the film American Gigolo, which established him as a leading man and a sex symbol...
's profession is incidental to the plot, the selection of the corporate raider who intends to destroy the hard work of a family-run business by acquiring the company in a hostile takeover and then selling off the company's parts for a profit (compared in the movie to an illegal chop shopChop shopIn motor vehicle theft, a chop shop is a location or business which disassembles stolen automobiles for the purpose of selling them as parts. It may also be used to refer to a location or business that is involved with the selling of stolen or fraudulent goods in general, an example of the latter...
). Ultimately, the corporate raider is won over and chooses not to pursue his original plans for the company.
Two other works were pivotal in framing the image of buyout firms.Barbarians at the Gate, the 1990 best seller about the fight over RJR Nabisco linked private equity to hostile takeovers and assaults on management. A blistering story on the front page of the Wall Street Journal the same year about KKR's buyout of the Safeway supermarket chain painted a much more damaging picture. The piece, which later won a Pulitzer Prize, began with the suicide of a Safeway worker in Texas who had been laid off and went on to chronicle how KKR had sold off hundreds of stores after the buyout and slashed jobs.
Contemporary reflections of private equity and private equity controversies
Carlyle group featured prominently in Michael Moore'sMichael Moore
Michael Francis Moore is an American filmmaker, author, social critic and activist. He is the director and producer of Fahrenheit 9/11, which is the highest-grossing documentary of all time. His films Bowling for Columbine and Sicko also place in the top ten highest-grossing documentaries...
2003 film Fahrenheit 9-11. The film suggested that The Carlyle Group exerted tremendous influence on U.S. government policy and contracts through their relationship with the president’s father, George H. W. Bush
George H. W. Bush
George Herbert Walker Bush is an American politician who served as the 41st President of the United States . He had previously served as the 43rd Vice President of the United States , a congressman, an ambassador, and Director of Central Intelligence.Bush was born in Milton, Massachusetts, to...
, a former senior adviser to the Carlyle Group. Additionally, Moore cited relationships with the Bin Laden family. The movie quotes author Dan Briody claiming that the Carlyle Group "gained" from September 11 because it owned United Defense
United Defense
United Defense Industries was a United States defense contractor which is now part of BAE Systems Land and Armaments. This company produces combat vehicles, artillery, naval guns, missile launchers and precision munitions.-History:...
, a military contractor, although the firm’s $11 billion Crusader artillery rocket system developed for the U.S. Army is one of the only weapons systems canceled by the Bush administration.
Over the next few years, attention intensified on private equity as the size of transactions and profile of the companies increased. The attention would increase significantly following a series of events involving The Blackstone Group: the firm's initial public offering and the birthday celebration of its CEO. The Wall Street Journal observing Blackstone Group's
Blackstone Group
The Blackstone Group L.P. is an American-based alternative asset management and financial services company that specializes in private equity, real estate, and credit and marketable alternative investment strategies, as well as financial advisory services, such as mergers and acquisitions ,...
Steve Schwarzman's 60th birthday celebration in February 2007 described the event as follows:
The Armory's entrance hung with banners painted to replicate Mr. Schwarzman's sprawling Park Avenue apartment. A brass band and children clad in military uniforms ushered in guests. A huge portrait of Mr. Schwarzman, which usually hangs in his living room, was shipped in for the occasion.
The affair was emceed by comedian Martin Short. Rod Stewart performed. Composer Marvin Hamlisch did a number from "A Chorus Line." Singer Patti LaBelle led the Abyssinian Baptist Church choir in a tune about Mr. Schwarzman. Attendees included Colin Powell and New York Mayor Michael Bloomberg. The menu included lobster, baked Alaska and a 2004 Louis Jadot Chassagne Montrachet, among other fine wines.
Schwarzman received a severe backlash from both critics of the private equity industry and fellow investors in private equity. The lavish event which reminded many of the excesses of notorious executives including Bernie Ebbers (WorldCom) and Dennis Kozlowski
Dennis Kozlowski
Leonard Dennis Kozlowski is a former CEO of Tyco International, convicted in 2005 of crimes related to his receipt of $81 million in purportedly unauthorized bonuses, the purchase of art for $14.725 million and the payment by Tyco of a $20 million investment banking fee to Frank Walsh, a former...
(Tyco International
Tyco International
Tyco International Ltd. is a highly diversified global manufacturing company incorporated in Switzerland, with United States operational headquarters in Princeton, New Jersey...
). David Bonderman
David Bonderman
David Bonderman is a founding partner of TPG Capital and its Asian affiliate, Newbridge Capital...
, the founder of TPG Capital remarked, "We have all wanted to be private – at least until now. When Steve Schwarzman's biography with all the dollar signs is posted on the web site none of us will like the furor that results – and that's even if you like Rod Stewart." As the IPO drew closer, there were moves by a number of congressman and senators to block the stock offering and to raise taxes on private equity firms and/or their partners—proposals many attributed in part to the extravagance of the party.
Rubinstein's fears would be confirmed when in 2007, the Service Employees International Union
Service Employees International Union
Service Employees International Union is a labor union representing about 1.8 million workers in over 100 occupations in the United States , and Canada...
launched a campaign against private equity firms, specifically the largest buyout firms through public events, protests as well as leafleting and web campaigns. A number of leading private equity executives were targeted by the union members however the SEIU's campaign was non nearly as effective at slowing the buyout boom as the credit crunch of 2007 and 2008 would ultimately prove to be.
In 2008, the SEIU would shift part of its focus from attacking private equity firms directly toward the highlighting the role of sovereign wealth fund
Sovereign wealth fund
A sovereign wealth fund is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments. Sovereign wealth funds invest globally. Some of them have grabbed attention making bad investments in several Wall Street financial...
s in private equity. The SEIU pushed legislation in California that would disallow investments by state agencies (particularly CalPERS and CalSTRS
CalSTRS
The California State Teachers' Retirement System provides retirement, disability and survivor benefits for California's 852,316 prekindergarten through community college educators and their families...
) in firms with ties to certain sovereign wealth funds. Additionally, the SEIU has attempted to criticize the treatment of taxation of carried interest
Taxation of private equity and hedge funds
Private 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...
. The SEIU, and other critics, point out that many wealthy private equity investors pay taxes at lower rates (because the majority of their income is derived from 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...
, payments received from the profits on a 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....
's investments) than many of the rank and file employees of a private equity
firm's portfolio companies.
See also
- 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...
- Business Development CompanyBusiness Development CompanyA Business Development Company is a form of publicly traded private equity in the United States created by Congress in 1980 as amendments to the Investment Company Act of 1940...