Hostile deals are now extremely rare. Even Britain's Philip Green, one of a small band of powerful individual private-equity financiers, declined to go hostile this year in his bid to buy Marks & Spencer, a British retailer. Indeed, big 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. Royal Dutch/Shell, a troubled oil giant, has been negotiating the sale of its liquefied-natural-gas business for $2.45 billion to KKR and Goldman Sachs Capital. Some companies even team up with private-equity firms, as Sony recently did with Texas Pacific Group (TPG) and Providence Equity Partners to buy MGM, a film studio.
Having largely shed the image of corporate wreckers, private-equity firms can now plausibly describe themselves as providing a safe haven in which firms can pursue long-term growth, sheltered from the short-term storms of the public stock markets. This role is all the more important because both venture capitalists and buy-out firms work increasingly with firms undergoing big changes. Well-known firms that have recently been "nurtured" by private equity include Burger King, Polaroid, Universal Studios Florida, Houghton Mifflin, Bhs, Ducati Motor and the Savoy Group.
Private-equity firms can also reasonably claim to offer a solution (though an expensive one) to the corporate-governance problems that have blighted so many public companies. "If you examine all the major corporate scandals of the past 25 years, none of them occurred where a private-equity firm was involved," noted Henry Kravis, one of the founders of KKR, in a recent speech. Private-equity firms, he said, are "vigilant in our role as owners, and we protect shareholder value." On the other hand, if there were any impropriety in a private company, the public might not get to hear about it.
Clearly, private equity is now a big business. In Britain, for instance, one-fifth of the workforce outside the public sector is employed by firms that are, or have been, invested in by a private-equity firm, according to the British Venture Capital Association. Worldwide, there are more than 2,700 private-equity firms, reckons Goldman Sachs (maybe many more, because in this private world small firms can easily drop below the radar screen). As pension funds, endowments and rich individuals have become increasingly keen investors, the amount of private equity has soared. In 2000 alone, the peak year so far, investors committed about $160 billion to private-equity firms (much of it to venture capital), up from only $10 billion in 1991.
At the same time, there has been a dramatic growth in the size of private-equity funds, and in the size of the top firms that manage them. Most private-equity firms raise funds as limited partnerships. The firm is the general partner that manages the fund and gets paid an annual fee (a percentage of the money in, or promised to, a fund) and later a large slice of any profits; outside investors (who often lock up their money for up to ten years) become limited partners who share only in the profits.
In 1980, the world's biggest fund (KKR's) was $135 million. Today there are scores of funds with over $1 billion each. J.P. Morgan's latest one is currently the biggest, at $6.5 billion, ahead of Blackstone's (see chart); Permira has Europe's largest, at around $6 billion at today's exchange rate. A $10 billion fund can be only a matter of time, if only for the fabulous annual fees.
Blackstone, which started life as a two-man band working from a single room, has become, in its own words, "a major player in the world of finance". It employs over 500 people in plush offices in New York's Park Avenue, Boston, Atlanta, London, Paris and Hamburg. The 35-40 firms in which it has a private-equity stake together have over 300,000 employees and annual revenues of over $50 billion — which, were they lumped together as a single conglomerate, would make Blackstone a top-20 Fortune 500 company. Other big private-equity firms can point to similar numbers. TPG's portfolio of firms has 255,000 staff and collective annual revenues of $41 billion; Carlyle's has 150,000 workers and revenues of $31 billion.
Yet the private-equity industry must now grapple with tough new challenges. These fall into three broad and overlapping categories: generating good financial performance; coming up with winning strategies in a rapidly maturing industry; and becoming more accountable to the public, and thus less private.
There are few industries in which the gap between the best and the rest is as large as in private equity. The top firms have delivered far better returns to investors than the stock markets have done, but the average private-equity fund has actually produced worse results (after fees) than public equities. That includes buy-out funds as well as the venture-capital funds that destroyed so much capital during the tech bubble a few years ago.
In future, the industry may find it hard to match even this not-too-glittering past performance. Private equity may become a victim of its own success. Techniques such as seeking to maximize cash flow, using debt astutely and paying managers with shares, which were novel when private-equity firms first introduced them in the 1970s, have become standard business practice. As Mr. Kravis put it in his recent speech, "Everything we have accomplished in driving corporate excellence makes it harder for us to achieve the returns that our investors expect from us."
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