- Private equity in the 1990s
Private equity in the 1990s relates to one of the major periods in the
history of private equity and venture capital. Within the broader private equityindustry, two distinct sub-industries, leveraged buyoutsand venture capitalexperienced growth along parallel although interrelated tracks.
The development of the
private equityand venture capitalasset classes has occurred through a series of boom and bust cycles since the middle of the 20th century. Private equity emerged in the 1990s 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 which had culminated in the collapse of Drexel Burnham Lambertand had caused the shutdown of the high-yield debtmarket. This period saw the emergence of more institutionalized private equity firms, ultimately culminating in the massive Dot-com bubblein 1999 and 2000.
LBO bust (1990 to 1992)
By the end of the 1980s the excesses of the buyout market were beginning to show, with the
bankruptcyof several large buyouts including Robert Campeau's 1988 buyout of Federated Department Stores, the 1986 buyout of the Revcodrug 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. [Wallace, Anise C. " [http://query.nytimes.com/gst/fullpage.html?res=9C0CE2D91E31F935A25754C0A966958260 Nabisco Refinance Plan Set] ." The New York Times, July 16, 1990.] 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).
The collapse of Drexel Burnham Lambert
Drexel Burnham Lambertwas the investment bankmost 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, arbitrageur Ivan Boesky. Largely based on information Boesky promised to provide about his dealings with Milken, the Securities and Exchange Commissioninitiated 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.cite book |last=Stone |first=Dan G. |title=April Fools: An Insider's Account of the Rise and Collapse of Drexel Burnham |year=1990 |publisher=Donald I. Fine |location=New York City |isbn= 1556112289]
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."Den of Thieves". Stewart, J. B. New York: Simon & Schuster, 1991. ISBN 0-671-63802-5.]
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. [http://www.referenceforbusiness.com/history2/5/New-Street-Capital-Inc.html New Street Capital Inc.] - Company Profile, Information, Business Description, History, Background Information on New Street Capital Inc at ReferenceForBusiness.com] 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.
high-yield debtmarkets had begun to shut down in 1989, a slowdown that accelerated into 1990. On February 13, 1990after being advised by Secretary of the Treasury Nicholas F. Brady, the SEC, the NYSEand the Federal Reserve, Drexel Burnham Lambertofficially filed for Chapter 11bankruptcy protection.
&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 debt, 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 Lambert, 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 yield of the junk bond market over U.S. treasuries (known as the "spread") had also increased by 700
basis points (7 percentage points). This made the cost of debt in the high yield market significantly more expensive than it had been previously. [Altman, Edward I. " [http://pages.stern.nyu.edu/~ealtman/report.pdf THE HIGH YIELD BOND MARKET: A DECADE OF ASSESSMENT, COMPARING 1990 WITH 2000] ." NYU Stern School of Business, 2000] [HYLTON, RICHARD D. [http://query.nytimes.com/gst/fullpage.html?res=9C0CEFD91231F932A25752C0A966958260 Corporate Bond Defaults Up Sharply in '89] New York Times, January 11, 1990.] 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 1989as a response to the savings and loan crisisof 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" founded in 1990 by Leon Black, a former Drexel Burnham Lambertbanker and Michael Milkenlieutenant;
Madison Dearborn" founded in 1992, by a team of professionals who previously made investments for First Chicago Bank. [ [http://query.nytimes.com/gst/fullpage.html?res=9E0CE5D8103CF934A35752C0A964958260&scp=4&sq=madison+dearborn&st=nyt COMPANY NEWS; Fund Venture Begun in Chicago] New York Times, January 7, 1992] ; and
TPG Capital" (formerly Texas Pacific Group) in 1992 by David Bondermanand James Coulter, who had worked previously with Robert M. Bass.
The second private equity boom and the origins of modern private equity
Beginning roughly in 1992, three years after the
RJR Nabiscobuyout, 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 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. [Source: Thomson Financial's [http://vx.thomsonib.com/ VentureXpert] database for Commitments. Searching "All Private Equity Funds" (Venture Capital, Buyout and Mezzanine).]
Resurgence of leveraged buyouts
Private equity in the 1980s was a controversial topic, commonly associated with
corporate raids, 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.” [http://www.economist.com/specialreports/displayStory.cfm?story_id=3398496/ The New Kings of Capitalism, Survey on the Private Equity industry] The Economist, November 25, 2004] 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 expendituresand provide incentives for management to build long-term value.
Thomas H. Lee Partnersacquisition of Snapple Beverages, in 1992, is often described as the deal that marked the resurrection of the leveraged buyout after several dormant years. [ [http://query.nytimes.com/gst/fullpage.html?res=9E0CE2D71F3CF930A35757C0A964958260 Thomas H. Lee In Snapple Deal] ( The New York Times, 1992)] Only eight months after buying the company, Lee took Snapple Beveragespublic and in 1994, only two years after the original acquisition, Lee sold the company to Quaker Oatsfor $1.7 billion. Lee was estimated to have made $900 million for himself and his investors from the sale. Quaker Oatswould 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 Partnersto the ranks of the largest private equity firms.
The following year,
David Bondermanand James Coulter, who had worked for Robert M. Bass during the 1980s completed a buyout of Continental Airlinesin 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 takeoverof TWA in 1985. [http://www.time.com/time/magazine/article/0,9171,1590446,00.html 10 Questions for Carl Icahn] by Barbara Kiviat, Time Magazine, Feb. 15, 2007] , 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 Airlineswould 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 Airlinesand Eos Airlines.
Among the most notable buyouts of the mid-to-late 1990s included:
Duane Reade", 1990, 1997:The company's founders sold Duane Reade to Bain Capitalfor approximately $300 million. In 1997, Bain Capital then sold the chain to DLJ Merchant Banking Partners[ [http://nymag.com/nymetro/shopping/features/11908/ The Mystery of Duane Reade] nymag.com. Retrieved July 3, 2007.] Duane Reade completed its initial public offering(IPO) on February 10, 1998
Sealy Corporation", 1997: Bain Capitaland a team of Sealy's senior executives acquired the mattress company through a management buyout [" [http://query.nytimes.com/gst/fullpage.html?res=9D0CE0D91330F937A35752C1A961958260 COMPANY NEWS; SEALY TO BE SOLD TO MANAGEMENT AND AN INVESTOR GROUP] ." New York Times, November 4, 1997]
KinderCare Learning Centers", 1997: Kohlberg Kravis Robertsand Hicks, Muse, Tate & Furst
J. Crew", 1997: Texas Pacific Groupacquired an 88% stake in the retailer for approximately $500 million, [STEINHAUER, JENNIFER. " [http://query.nytimes.com/gst/fullpage.html?res=9A06E3DE113FF93BA25753C1A961958260 J. Crew Caught in Messy World of Finance as It Sells Majority Stake] ." New York Times, October 18, 1997] however the investment struggled due to the relatively high purchase price paid relative to the company's earnings. [KAUFMAN, LESLIE and ATLAS, RIVA D. " [http://query.nytimes.com/gst/fullpage.html?res=980DE6DE103EF93BA15757C0A9649C8B63 In a Race to the Mall, J. Crew Has Lost Its Way] ." New York Times, April 28, 2002.] The company was able to complete a turnaround beginning in 2002 and complete an initial public offering in 2006 [ROZHON, TRACIE. " [http://www.nytimes.com/2004/12/09/business/09retail.html New Life for a Stalwart Preppy: J. Crew's Sales Are Back] ." New York Times, December 9, 2004.]
Domino's Pizza", 1998:Bain Capital acquired a 49% interest in the second-largest pizza-chain in the US from its founder [" [http://query.nytimes.com/gst/fullpage.html?res=9C06E7DD1239F935A1575AC0A96E958260 COMPANY NEWS; DOMINO'S PIZZA FOUNDER TO RETIRE AND SELL A STAKE] ." New York Times, September 26, 1998] and would successfully take the company public on the New York Stock Exchange(NYSE:DPZ) in 2004. [" [http://query.nytimes.com/gst/fullpage.html?res=9F01E4DC163BF937A25757C0A9629C8B63 Domino's Pizza Plans Stock Sale] ." New York Times, April 14, 2004.]
Regal Entertainment Group", 1998: Kohlberg Kravis Robertsand Hicks, Muse, Tate & Furst acquired the largest chain of movie theaters for $1.49 billion, including assumed debt. [MYERSON, ALLEN R. and FABRIKANT, GERALDINE. " [http://query.nytimes.com/gst/fullpage.html?res=9C0CE6DF1E38F932A15752C0A96E958260 2 Buyout Firms Make Deal To Acquire Regal Cinemas] ." New York Times, January 21, 1998.] The buyers originally announced plans to acquire Regal, then merge it with United Artists(owned by Merrill Lynchat the time) and Act III(controlled by KKR), however the acquisition of United Artists fell through due to issues around the price of the deal and the projected performance of the company. [" [http://query.nytimes.com/gst/fullpage.html?res=9A0CE1D61E3FF932A15751C0A96E958260 COMPANY NEWS; HICKS, MUSE DROPS DEAL TO BUY UNITED ARTISTS ] ." New York Times, February 21, 1998.] Regal, along with the rest of the industry would encounter significant issues due to overbuilding of new multiplex theaters [PRISTIN, TERRY. " [http://query.nytimes.com/gst/fullpage.html?res=9F02E0DF1E30F937A3575AC0A9669C8B63 Movie Theaters Build Themselves Into a Corner] ." New York Times, September 4, 2000] and would declare bankruptcy in 2001. Billionaire Philip Anschutzwould take control of the company and later take the company public. [" [http://query.nytimes.com/gst/fullpage.html?res=9C02E3D9133FF930A25753C1A9679C8B63 COMPANY NEWS; REGAL CINEMAS, THEATER OPERATOR, FILES FOR BANKRUPTCY] ." New York Times, October 13, 2001.]
*"Oxford Health Plans", 1998:An investor group led by Texas Pacific Group invested $350 million in a convertible preferred stock that can be converted into 22.1% of Oxford. [Norris, Floyd. " [http://query.nytimes.com/gst/fullpage.html?res=9805E6D9153EF936A15751C0A96E958260 SHAKE-UP AT A HEALTH GIANT: THE RESCUERS; Oxford Investors Build In Some Insurance, in Case Things Don't Work Out] ."
New York Times, February 25, 1998.] The company completed a buyback of the TPG's PIPE convertible in 2000 and would ultimately be acquired by UnitedHealth Groupin 2004. [" [http://query.nytimes.com/gst/fullpage.html?res=9A01EED91031F935A15753C1A9669C8B63 COMPANY NEWS; PROFITS TRIPLE AT OXFORD; TEXAS PACIFIC BUYBACK SET] ." New York Times, October 26, 2000.]
Petco", 2000: TPG Capitaland Leonard Green & Partnersinvested $200 million to acquire the pet supplies retailer as part of a $600 million buyout. [" [http://query.nytimes.com/gst/fullpage.html?res=9C03E2D8173AF93BA25756C0A9669C8B63 COMPANY NEWS; MANAGEMENT-LED GROUP TO BUY PETCO FOR $505 MILLION] ." New York Times, May 18, 2000] Within two years they sold most of it in a public offering that valued the company at $1 billion. Petco’s market value more than doubled by the end of 2004 and the firms would ultimately realize a gain of $1.2 billion. Then, in 2006, the private equity firms took Petco private again for $1.68 billion. [" [http://www.nytimes.com/2006/07/15/business/15petco.html 2 Equity Firms to Acquire Petco ] ." Bloomberg, July 15, 2006.]
As the market for private equity matured, so too did its investor base. The
Institutional Limited Partner Associationwas initially founded as an informal networking group for limited partnerinvestors in private equity funds 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 to 2000)
In the 1980s,
FedExand Apple Inc.were able to grow because of private equity or venture funding, as were Cisco, Genentech, Microsoftand Avis. [ [http://fusion.dalmatech.com/%7Eadmin24/files/private_equity_intro.pdf "Private Equity: Past, Present, Future"] , by Sethi, Arjun May 2007, accessed October 20, 2007.] 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 mangers, 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 Metrickrefers 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 bubblein 2000. [Metrick, Andrew. "Venture Capital and the Finance of Innovation." John Wiley & Sons, 2007. p.12]
The late 1990s were a boom time for the venture capital, as firms on
Sand Hill Roadin Menlo Parkand Silicon Valleybenefited 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.
Yahoo!" - On April 5, 1995, Sequoia Capitalprovided Yahoo with two rounds of venture capital. [cite web|url=http://yhoo.client.shareholder.com/press/timeline.cfm|title=Yahoo Company Timeline|accessdate=2007-11-13] On 12 April 1996, Yahoo had its initial public offering, raising $33.8 billion dollars, by selling 2.6 million shares at $13 each.
The bursting of the Internet Bubble and the private equity crash (2000 to 2003)
Nasdaqcrash 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 their 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' [http://www.pwcmoneytree.com/moneytree/index.jsp 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.comand Salesforce.comIPOs) 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.
History of private equity and venture capital
Early history of private equity
Private equity in the 1980s
Private equity in the 21st century
Private equity firm
Private equity fund
Private equity secondary market
Private investment in public equity
Taxation of Private Equity and Hedge Funds
Mergers and acquisitions
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*Bance, A. (2004). [http://www.evca.com/pdf/Invest.pdf Why and how to invest in private equity] . European Private Equity and Venture Capital Association (EVCA). Accessed May 22, 2008.
*Bruck, Connie. "Predator's Ball". New York: Simon and Schuster, 1988.
*Burrill, G. Steven, and Craig T. Norback. The Arthur Young Guide to Raising Venture Capital. Billings, MT: Liberty House, 1988.
*Burrough, Bryan. "
Barbarians at the Gate." New York : Harper & Row, 1990.
*Craig. Valentine V. [http://www.fdic.gov/bank/analytical/banking/2001sep/br2001v14n1art2.pdf Merchant Banking: Past and Present] . FDIC Banking Review. 2000.
*Fenn, George W., Nellie Liang, and Stephen Prowse. December, 1995. The Economics of the Private Equity Market. Staff Study 168, Board of Governors of the Federal Reserve System.
*Gibson, Paul. "The Art of Getting Funded." Electronic Business, March 1999.
*Gladstone, David J. Venture Capital Handbook. Rev. ed. Englewood Cliffs, NJ: Prentice Hall, 1988.
*Hsu, D., and Kinney, M (2004). [http://brie.berkeley.edu/~briewww/publications/WP163.pdf Organizing venture capital: the rise and demise of American Research and Development Corporation] , 1946-1973. Working paper 163. Accessed May 22, 2008
*Littman, Jonathan. "The New Face of Venture Capital." Electronic Business, March 1998.
*Loos, Nicolaus. [http://www.unisg.ch/www/edis.nsf/wwwDisplayIdentifier/3052/$FILE/dis3052.pdf Value Creation in Leveraged Buyouts] . Dissertation of the University of St. Gallen. Lichtenstein: Guttenberg AG, 2005. Accessed May 22, 2008.
*National Venture Capital Association, 2005, The 2005 NVCA Yearbook.
*Schell, James M. "Private Equity Funds: Business Structure and Operations." New York: Law Journal Press, 1999.
*Sharabura, S. (2002). [http://media.www.chibus.com/media/storage/paper408/news/2002/02/18/GsbBusiness/Equity.Past.Present.And.Future-187504.shtml Private Equity: past, present, and future] . GE Capital Speaker Discusses New Trends in Asset Class. Speech to GSB 2/13/2002. Accessed May 22, 2008.
*Trehan, R. (2006). [http://www.4hoteliers.com/4hots_fshw.php?mwi=1757 The History Of Leveraged Buyouts] . December 4, 2006. Accessed May 22, 2008.
*Cheffins, Brian. " [http://www.cbr.cam.ac.uk/pdf/wp339.pdf THE ECLIPSE OF PRIVATE EQUITY] ". Centre for Business Research, University Of Cambridge, 2007.
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