Many private equity professionals today think that private equity has always been the way it is currently. In fact, the origins of modern private equity date back to a bit after World War II when two major venture capital firms were founded, the American Research and Development Corporation (ARDC) and J.H. Whitney & Company. ARDC was founded to help private sector businesses that were run by soldiers returning from World War II. J.H. Whitney invested in a variety of companies, some of which were focused on providing soldiers with nutrition and others related to food and other entertainment. It was not until the late 1950s and early 1960s that leveraged buyouts were popularized and companies like KKR looked to acquire family-owned businesses that were too small to be taken public and/or the families were unwilling to sell to competitors. In the 1970s and 80s, several of these major buyout firms emerged, including Thomas H. Lee Partners; Clayton & Dubilier; Welsh, Carson, Anderson & Stowe; GTCR; and several firms in Europe.
The first private equity boom began in the 1980s, particularly from 1982 to 1993. During this ~10 year period, the public became aware of what private equity firms were capable of, particularly their ability to affect large companies and execute takeovers that could be friendly but were more often hostile. The 1989 buyout of RJR Nabisco remained the largest buyout for 17 years afterward. Over this period, the private equity industry grew from $2.4 billion in investor commitments in 1980 to almost $22 billion in 1989, showing tremendous exponential growth in less than a decade.
Today, after private equity firms have experienced several economic cycles since the 1980s, private equity is still incredibly relevant to the modern economy because it drives growth for companies and provides attractive returns for investors. In difficult or uncertain times, such as the 2008 crash or the COVID-19 pandemic, private equity becomes even more important since firms can provide companies with much-needed capital and industry expertise. With the uncertainty of public markets, private equity becomes attractive to investors on a valuation basis and investors may look to private equity as a way to greatly diversify their portfolios. Private equity investors look to not only invest in companies but also add value to them for their own fund returns as well as improve some aspect of the industry they are in, whether that is energy, healthcare, technology, or anything else.
Private equity firms played a major role in furthering the development of our economy during the COVID-19 pandemic. According to a report from Deloitte, private equity firms helped portfolio companies navigate the pandemic in three major ways. First, they managed inventory and cash flow through agile execution, which the companies might not have been able to achieve solely with their own financial and advisory capabilities. Second, private equity firms shared best practices for building digital capabilities with their portfolio companies. Many family-owned and small businesses have not yet upgraded their systems to match the capabilities of today’s digital age. So, the push from private equity ownership helped a lot of these businesses upgrade their internal software and processes as well as formalized information sharing across the company and in the company’s broader industry. Lastly, private equity firms helped to rightsize and review the operating model of support functions in their companies. Some firms helped their portfolio companies develop crisis management plans and stricter investment guidelines so that firms and companies alike could generate more growth and returns.
In addition, a lot of the value-add a private equity firm provides to a portfolio company is in the network the firm provides. Besides providing financial assistance, private equity firms provide industry and/or management expertise from experts on the investment team as well as advice from the firm’s senior advisors. For example, at the private equity firm I work at, we leverage the expertise of senior advisors, who have had long tenures in their industries, during deal processes to evaluate an opportunity and seek their advice during our ownership of the company if we choose to do the deal. As private equity professionals, we are experts in operating and providing value; the technical skills and know-how of someone who is an expert in a particular industry allow us to be even better at our jobs and provide more value to our portfolio companies. Often, we will facilitate exchanges between portfolio companies within the same industry (since they are not in direct competition with each other, as we avoid making investments that will cannibalize one another’s growth). The CEOs can discuss strategy, the CFOs can discuss financials, and other members of management can draw on each other’s experiences to maximize the performance of their respective companies. These types of learning opportunities are made possible by the private equity sponsor they have in common.
Since private equity can bring an enormous amount of value to companies, experts often speculate if demand for private capital will continue to rise. Put simply, the answer still appears to be yes. The demand for private funds is increasing as investors seek high returns and perceive low volatility. In fact, institutional investors (pension funds, insurance companies, endowments, banks, family offices, foundations, etc.) are expected to increase their fund allocations in private equity over the next several years due to the asset class’ great performance through economic cycles. Institutions like endowments already place a large emphasis on investing in private equity firms given that they rely on more stable returns to provide value to the universities they serve. We would expect to see this grow over the next decade and beyond.
Overall, if there is one major takeaway from this piece, it is that private equity will continue to play a major role in the lives of investors and the trajectory of our modern economy. The world not only survives on private capital; it develops and thrives with the help of investors such as private equity firms. While it can be tempting to follow trends of new, perhaps more “chic” asset classes like crypto or NFTs, private equity will likely be an asset class that continues to truly stand the test of time.
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