The History of Private Equity

The History of Private Equity

In 1901, the World's Wealthiest Investors Created Private Equity And Turned "Millions Into Billions"

An Investment U White Paper

From the Investment U Research Team

The private equity market is an ultra-exclusive market reserved for only the ultra-wealthy elite. And in the last decade, it generated hundreds of billions more to its bottom line, making quite a few savvy investors even richer... (See "How to Get Rich on the Private Equity Investment Boom.")

But while the private equity market has ballooned well over a trillion in recent years, the history of private equity and its creation can be traced back to the town of Pittsburgh... and the year 1901.

That's the year J.P. Morgan bought Carnegie Steel Company from Andrew Carnegie and Henry Phipps for $480 million, the first trade on what would become the private market we know today.

In 1907, Phipps founded the Bessemer Trust, a "family office," to invest his $50 million in proceeds in private businesses and other exclusive holdings.

Today, Bessemer Trust continues to invest more than $46 billion in assets for the Phipps family and other mega wealthy American dynasties... Headed by Phipp's great grandson, Stuart Janney,  it invests in privately traded companies to this day.

But it wasn't until after World War II that the private market really began growing...

Private Equity Returns 52,757%, Historically Speaking...

[cfsp name="research-banner"] American Research and Development Corp. and J.H. Whitney & Company, two of the earliest venture capital firms, were both established in 1946. ARD was founded by Georges Doriot, the "father of venture capitalism," whose greatest investment was inarguably Digital Equipment Corp., which he bought for $70,000 and sold for $37 million - an increase of 52,757%.

As for J.H. Whitney, its most famous investment was an innovative method for delivering nutrition to U.S. troops, which came to be known as Minute Maid Orange Juice.However, the private equity movement would not be what it is today, if it weren't for the events of 1958...

The U.S was in the grips of Cold War terror. In an effort to bump up technological advances against the Soviets, President Eisenhower enacted the Small Business Act of 1958. It allowed licensed venture capital firms, known as "Small Business Investment Companies," or SBICs, to borrow money from the government at below-market interest rates. In turn, they had to invest in entrepreneurial ventures.

Meanwhile, a number of independent venture capital firms started establishing themselves as major players. Since they didn't depend on government support, they offered more flexibility... and were therefore more attractive to investors. Sure enough, in a few short years, there were more of these private companies than SBICs.

The Rise of Kohlberg Kravis & Roberts

Then the market got really hot in the 1960s... IPO's were the latest and greatest darlings of Wall Street. That included Digital Equipment Corp., the wildly successful ARD start-up that went public in 1968. But that was only part of the boom...

In 1964, Kohlberg Kravis Roberts & Co. steered private investments in another direction with the first official leveraged buyout, then called a "bootstrap" transaction. In this deal, KKR swooped in and bought Orkin Exterminating Company. It was a revolutionary idea... one that would be all but forgotten until the 1980s.

You see, it all came to a screeching halt in the early '70s. In fact, it was an ugly decade for investments across the board. The government raised capital gains taxes... And after the stock market crash of 1974, investors avoided anything new and uncertain...

Additionally, due to the Employee Retirement Income Security Act of 1974 (ERISA), pension funds couldn't participate in any kind of "risky" investments. It got so bad that fund raising reached an all-time low in 1975. According to the Venture Capital Institute, a total of only $10 million was raised for the year.

But what goes down must eventually go up... as was the case in 1978. Time magazine reports that fund raising increased from $39 million in 1977 to $570 million just one year later.

The Institutions Pour Into Private Equity...

But why the sudden rush of money? For one, the government lowered capital gains tax from a maximum of 49% to 28%. Then Washington relaxed some of the hard-hitting legislation from ERISA, thus allowing pension funds to invest in private equity... As a result, institutional investor began piling into these investments.

Fed Ex... Apple Computer... Intel... Genentech... all success stories of this venture capital wave.

At the same time, leveraged buyouts were quickly becoming the preferred vehicle for private capital. Major players were just throwing their hats in the ring:

  • Bain Capital in 1984
  • Blackstone Group in 1985
  • Carlyle in 1987
  • ABRY Partners in 1989.

Leveraged buyouts in the 1980s came to epitomize the "ruthless capitalism" and "greed" pervading Wall Street at the time. And one example in particular comes to mind...

In 1989, KKR closed in on a $31.1 billion takeover of RJR Nabisco. It was 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.

And now, according to USA Today,

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.

Whether today's private equity firms are simply a regurgitation of their counterparts in the 1980s or a kinder, gentler version remains up in the air at this point. But what is far less difficult to refute is that it stands as a very powerful form of investment in the right hands.

Good investing,

The Investment U Research Team