The statement by Henry Kravis that private equity was in its “golden era” might sound like hubris to the unacquainted observer but may actually not be far off from the reality given the growth of private equity funds under management since the advent of large-scale leveraged buy-outs (LBOs) in the 1980s. Henry Kravis as a principal partner in Kohlberg, Kravis & Roberts (KKR) pioneered LBOs in the late 1970s and KKR has been a major private equity firm since having reportedly invested in over 160 companies since 1977 (KKR website, 2009). Henry Kravis spoke on the back of unprecedented record funds raised by private equity firms in 2006. According to the Dow Jones Private Equity Analyst newsletter of January 2007, U.S private equity firms raised $255 billion in 404 funds followed by $302 billion in 415 funds in 2007. In 2007 U.S private equity firms raised this money in the middle of the turmoil of the credit crisis which was just beginning to shake financial markets worldwide. Private equity as an asset class has always been attractive due to the higher returns as compared to public equity. Many studies have confirmed that private equity investments have consistently outperformed public equity markets. For instance, according to research flash paper released in January 2012 by the firm Partners Group, “since 2000, private equity investments have outperformed public equity indices by 5% in North America and 9% in Europe per annum, in the aftermath of the burst of the internet bubble (Q2 2000 to Q1 2003) private equity investments outperformed public markets by 6% in North America and 20% in Europe on a annualized basis and during the financial crisis from Q3 2007 to Q1 2009 private equity investments beat public market indices by 19% in both North America and Europe on an annualized basis”. For further illustration, Exhibit 1.1 below also shows the private equity investment levels in North America from around 2001 to 2007.
From the background set above one can then argue that private equity did indeed go through a “golden era” of sorts post-2000 that is. We now need to discuss the key drivers of the expansion of private equity firms since 2000. For our discussion, we need to have a “working, all-encompassing definition” of private equity. Private equity consists of “pools of capital invested by private equity partnerships typically involving the purchase of majority stakes in companies and/or entire business units to restructure the capital, management and organization” (IMF, Global Financial Stability Report: Containing systemic risks and restoring financial soundness 121, 2008). The first key driver of the expansion of private equity firms since 2000 was the low global interest rates that prevailed. Private equity firms use a lot of debt to purchase portfolio companies. Since 2000, global savings and liquidity were plentiful and as such private equity firms could not only borrow money at relatively low rates but they could also attract larger investments from pension funds, life insurance firms and other institutional investors who were seeking higher returns that were prevalent in private equity. Private equity returns were high because private equity firms not only changed the capital structure of the portfolio firms they acquired but were also able to drive operational improvements that would lead to portfolio companies becoming more profitable. On exit the private equity firms would make significant profits for their investors. It must be noted that it’s not all private equity firms that attracted more capital but rather the firms that had a consistent record of delivering excellent returns for investors. This is why the top private equity firms like Blackstone, KKR, The Carlyle Group, TPG, Bain Capital, Apollo Advisors and Warburg Pincus consistently raised billions of dollars for their buyout funds. Yet another driver of the expansion of private equity firms since 2000 was increased corporate governance...
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