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Private Equity

Defining Events

Many important events—such as the establishment of the modern private equity industry in the 1970s, federal regulation of private equity firms and managers, and the slow, but steady, emergence of women in private equity—have shaped the private equity (PE) industry.

The Barbarians at the Gate

Many credit Kohlberg Kravis Roberts & Co. with inventing modern private equity investing. The firm was founded in 1976 by Jerome K. Kohlberg Jr. and cousins Henry Kravis and George R. Roberts. The three founders worked together at Bear Stearns Cos. Inc. in the 1970s before quitting to form KKR. Like many private equity firms, KKR started simple, buying up three small, relatively unknown companies in 1977, and three more the following year. KKR was different, however, in how it structured its financing, putting up less of its investors’ money in each transaction. Instead, KKR used—and still uses—about 25 percent of its own capital in a transaction, financing the rest through bank loans and high-yield bond issuance. This strategy typically generated massive returns on investment (much higher than firms that used their own funds to finance deals).

With such strong returns, KKR quickly ramped up its takeover activity. It closed six different transactions in 1981, and by 1985 it had purchased the Motel 6 chain, followed a year later by the Safeway grocery stores. In 1987, Kohlberg resigned at age 61, leaving Kravis as senior partner.

KKR then started looking for a new deal—and found a big one. KKR, and Henry Kravis in particular, came to symbolize the private takeover with a $31.4 billion acquisition of RJR Nabisco in 1988. The takeover was a brutal process, with KKR facing opposition and competing bids from RJR’s own management. But the lack of a guaranteed price by management and word of then-CEO F. Ross Johnson’s lucrative “golden parachute” deal in the event of a buyout ultimately tipped the board’s vote toward KKR’s offer. The back-and-forth among KKR, the board, and management was ultimately the subject of a best-selling book, Barbarians at the Gate, and even an HBO movie starring James Garner and Jonathan Pryce.

Surprisingly, while the deal made KKR the poster child for private equity—and, some say, corporate greed—the deal itself wasn’t a great one. Many say that, amid the merger boom of the 1980s, Kravis and his firm simply paid too much for RJR. And KKR was the victim of poor timing as well. An increasing number of tobacco-related lawsuits and intense competition among cigarette makers hurt RJR’s profits in that division. The economic downturn and recession of 1990-91 made it more difficult for RJR to raise money in the debt markets, prompting KKR to throw in another $1.7 billion of its own money to prop up RJR’s operations. Ultimately, KKR exited the investment in 1995, transferring some of RJR’s assets to another portfolio company—Borden Foods—and leaving the remnants on the open market. After its total $3.1 billion investment in RJR Nabisco, KKR was said to have barely broken even on the deal—if that.

Yet the ultimate failure of the investment was drawn out over at least seven years, and the sheer audacity of the deal made Kravis and Roberts the Wall Street equivalent of rock stars. Banks were perfectly happy to lend KKR greater amounts to use as leverage because no matter how the investments ended up, the fees were worth it—after all, investment banks and lenders walked away from the RJR Nabisco deal with $1 billion in payments. The success of KKR also prompted other private equity firms, such as The Blackstone Group, Bain Capital, and The Carlyle Group, to become even more aggressive.

Leveraged buyouts took a backseat to the technology boom in the 1990s, but KKR remained busy, regaining its stride and buying up such diverse corporations as Spalding Holdings Corp. and Act III Cinemas Inc. Investment in its takeover funds slowed from 2000 to 2002 because of a sluggish stock market, but KKR was one of the leaders in the private equity boom over the first decades of the 21st century.

That said, KKR isn’t leading the barbarian hordes at the gate these days. Unlike its 1980s heyday, KKR is far more willing to team up with rival private equity firms for so-called “club deals,” in which the risks and rewards of acquisitions are shared among a number of private equity funds. And the “hotshot” role that Henry Kravis enjoyed in the late 1980s has been taken on by The Blackstone Group’s Stephen Schwarzman.

Nonetheless, KKR remains one of the leading private equity firms on Wall Street and is certainly the elder statesman of the industry. As of March 31, 2023, the firm had $510 billion in assets under management; offices in 23 cities in 17 countries across four continents; and 127 portfolio companies in its private equity funds that generated $288 billion in annual revenues. As of December 31, 2021, its portfolio companies employed a total global workforce of approximately 754,542.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, Deregulation, and Renewed Efforts to Regulate the Industry

The private equity industry was largely unregulated for decades, but in the 2000s, the Securities and Exchange Commission (SEC) began to take a closer look at the industry as a result of accusations of improper fees and compliance violations, as well as investor concerns regarding industry transparency. In 2023, the SEC adopted amendments to Form PF (the confidential reporting form for certain SEC-registered investment advisers to private funds.) The amendments will require all private equity fund advisers to file current reports regarding the occurrence of reporting events that could indicate significant stress at a fund or investor harm. The SEC says that the “amendments are designed to enhance the ability of the Financial Stability Oversight Council to assess systemic risk and to bolster the commission’s oversight of private fund advisers and its investor protection efforts.” Reporting events for private equity fund advisers include certain fund termination events, the removal of a general partner, and the occurrence of an adviser-led secondary transaction. The SEC has also proposed new rules and amendments under the Investment Advisers Act of 1940 as a way to protect private fund investors and enhance the regulation of private fund advisers.

In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires all private equity firms with more than $150 million in assets under management to register with the SEC and to hire a chief compliance officer to create and monitor a compliance program, disclose more information about investor agreements, and submit to regular SEC inspections, among other rules. Additionally, the Volcker Rule, a regulation in Dodd-Frank, prohibits banks from conducting certain investment activities with their own funds and prohibits them from investing in or sponsoring private equity or hedge funds.

The tax reform bill passed by Congress in late 2017 also had an effect on the financial industry. Experts believed that it would help companies owned by private equity firms as a result of the reduction of the corporate tax rate from 35 percent to 21 percent and other changes.

The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 rolled back some aspects of Dodd-Frank. It changed the financial threshold in which banks could be classified as “systematically important financial institutions” from those that had more than $50 billion in assets to those with $250 billion in assets. Additionally, the act also provides smaller banks with relief from the Volcker Rule. Banks with less than $10 billion in assets may now invest in or sponsor private equity or hedge funds and engage in proprietary trading.

The recent trend is toward more oversight of the alternative investment industry by the SEC and Congress, but this trend could once again shift toward reduced regulation and oversight in the future depending on which political party controls Congress and the White House.

Women Seek to Break the Glass Ceiling

Women and ethnic minorities are vastly underrepresented in the private equity industry. While half of U.S. investment capital comes from women, in 2022 only 20.5 percent of all private equity professionals worldwide were women, according to Preqin, an alternative investment research firm. This is a slight increase from 17.9 percent in 2019. But only 13.9 percent of senior managers and executives were women. Women held only 26.2 percent of chief financial officer roles in North American PE firms. On the brighter side, women accounted for 46.9 percent of investor relations and marketing professionals and 36 percent of finance and accounting professionals. Less than 17 percent of executive/senior-level positions in investment banking are held by women, according to Catalyst, a nonprofit advocacy group for women in business.

In the past 20 years, professional associations and some private equity firms have made efforts to encourage more women to enter into and succeed in the PE industry. One groundbreaking organization is the Association of Women in Alternative Investing, which seeks to increase the number of women in the alternative investment industries (including in private equity) by providing mentorship, networking, and education opportunities for women who are currently working in or contemplating entering these fields. The Private Equity Women Investor Network was founded in 2007 as a forum for senior-level women in private equity to network and participate in educational events. Another organization is 100 Women in Finance, which was founded as 100 Women in Hedge Funds in 2001 by three female professionals who sought to bring 100 women into the hedge fund industry together in order to “teach women to better leverage their collective relationships and improve communication within the alternative investment industry.” Since the organization expanded its outreach to other sectors in the financial industry, membership has really taken off. It now has more than 15,000 members in 26 locations across four continents, and it offers free membership to students. The organization has established the 30×40 Vision goal, in which women will occupy 30 percent of investment team and executive leadership roles by 2040. In addition, private equity firms such as KKR, Blackstone, and The Carlyle Group are increasing their efforts to create a more diverse workforce. They’re funding fellowships to increase diversity in the industry, recruiting female analysts from other industries (such as consulting) that typically feature a better gender balance, launching summer internship programs that target female undergraduates, and implementing more female-friendly practices and fringe benefits. Other than retaining talent, 53 percent of managers of funds with more than $15 billion in assets said that “increasing diversity” was their top talent management priority, according to the 2023 Global Private Equity Survey from EY. “Ensuring a more inclusive culture” ranked second (47 percent of respondents felt this was the important priority).

Despite efforts and successes, a 2022 survey by the business consulting firm Semaphore found that sexual misconduct and discrimination remain a major issue in private capital markets. Sixty-nine percent of professionals in the private capital industry who were surveyed by Semaphore reported that sexual assault, harassment, and gender bias were problems—down from the 80 percent who felt that way in 2018.

The COVID-19 Pandemic and the Private Equity Industry

In late 2019, the coronavirus COVID-19 was detected in China and quickly spread to nearly every country causing hundreds of millions of infections, more than 7 million deaths, and massive business closures and job losses. In the short-term, the COVID-19 pandemic negatively affected the health of individuals; employment opportunities at businesses, nonprofits, and government agencies; and daily life. The pandemic also affected job-seekers and employees. Some companies cancelled or delayed internships and other experiential learning opportunities, while others converted them to an online format. Onboarding of new hires was either delayed or moved to an online format by many companies. Most employers transitioned in-person interviews to telephone and online equivalents, and many businesses transitioned employees to remote work or reduced staff in the face of business lockdowns and social distancing requirements to prevent the spread of the virus.

The pandemic had a significant, short-term negative affect on the private sector industry, with deal counts down 36 percent in the first half of 2020 (as compared to the same period in 2019). The lockdowns made it much harder—and sometimes impossible—for firms to fundraise (although virtual fundraising efforts were initiated by some companies), complete due diligence on target companies, visit production facilities (if they were open), and effectively manage portfolio companies. Valuations of some portfolio or target companies also declined because of stagnant sales or other stresses on their businesses. New weaknesses were also revealed at some portfolio or target companies as the pandemic caused sales to drop, manufacturing supply lines to be severed, or operating capital to dry up. Firms also deprioritized exits due to health, humanitarian, and business disruptions. Announced exits decreased almost 70 percent globally in May 2020 as compared to May 2019, according to McKinsey & Company. Private equity portfolio companies in retail (except supermarkets), travel, and hospitality faced strong economic headwinds as people bought fewer products in-person and traveled less. Many private equity firms focused on supporting their existing holdings (such as retail, entertainment, and hospitality companies), many of which have been negatively affected by pandemic shutdowns and reduced sales.