Most of us will never write a business plan, much less
sign a term sheet, celebrate a letter of
intent, or, perish the thought, ''go public.''
So why the craze for private equity? The term is more or less
synonymous with ''venture capital''
around the world, though in the United States it encompasses
a significant ''buyout'' industry, too,
devoted to the restructuring of large and well-established companies.
Yet the first true venture firm, American Research and Development,
was formed only in 1946 - as a
closed-end publicly traded fund marketed mainly to individuals.
Private partnerships followed only
once the concept was proven. And it wasn't until 1979, when the
US Labor Department interpreted
the Employee Retirement Income Security Act as permitting pension
managers to invest broadly in
higher-risk enterprises, that the money really started to pour
Since then, the venture industry has been on a roller coaster:
down in the late 1980s, but almost
entirely up since then. Private equity funds have grown from
$5 billion in 1980 to more than $175
billion in 1999.
Some of the fascination has to do with the fact that venture and
buy-out firms are among the
foremost architects of the New Economy. Their principals behave
with the verve we have come to
expect of architects everywhere.
Some of the interest has to do with the alchemy of personal wealth,
Quite aside from the relentless hoopla in the business magazines,
three serious books about the
start-up industry have appeared in the last month or so. Each
casts light on the process from its own
perspective. (A gripping account of an e-commerce start-up by
a journalist-turned-entrepreneur -
''The Leap,'' by Thomas Ashbrook - is to appear in May.)
Joseph W. Barlett is a wise lawyer old enough to have worked on
his first fund in 1963. He spent his
first night at the printer overseeing an offering prospectus
not long thereafter. A former law clerk to
Chief Justice Earl Warren, former undersecretary of commerce,
and a past president of the Boston
Bar Association, Barlett wrote ''Fundamentals of Venture Capital''
as a practical guide for those
starting out to form a company - or thinking of investing in
The book takes readers through ''the rules, the customs, the norms,
the financial technology, the myths
(if you like,) [and] the conventional wisdom'' of the industry,
including a most edifying discussion (for
nonlawyers) of minimizing taxes in the early stages. He's seen
it all and come to the conclusion that
the the cyclical imperative to cash out in timely fashion is
a little too strong for healthy corporate
''We continue to have an unbridgeable chasm separating public
companies from private companies,''
writes Barlett. ''A sensible regulation would suggest, in my
view, that there be comfort stations along
the way, places in which adolescent firms could reside on their
journey from the embryo to the IPO.''
Yet regulators gripped by tradition aren't even studying the
possibility, he says.
Josh Lerner, too, is interested in the effect of financing decisions
on the life cycle of particular
businesses. A professor at Harvard Business school, Lerner is
among the nation's foremost experts
on the economics of the industry.
''Venture Capital and Private Equity: A Casebook'' grew out of
a course first offered at the school in
1993. Its 29 cases take you as close to business school as you
can get without forking over tuition. It
amounts to a guide to investment styles of the rich and famous.
There's an awful lot of background knowledge packed in these essentially
journalistic treatments of
particular investment opportunites: why wealthy families have
historically taken the lead in private
equity investing; how funds' high-powered compensation schemes
are designed to tie investors to the
firms they monitor as tightly as possible; and what the thicket
of specialized terms endemic to the
industry actually mean.
Despite a certain tendency to boom and bust, Lerner is optimistic
about the industry. A ''virtuous
circle'' may be at work, he says. More private equity has meant
better conditions for new
investments, which in turn have led to greater capital formation.
And now perhaps the US model will
be adapted successfully overseas.
Amar V. Bhide is an old-fashioned scholar, Harvard Business School-trained
and now teaching at the University of Chicago, who is determined to follow
in the paths of Joseph Schumpeter and Alfred
Chandler. A former McKinsey consultant and E. F. Hutton trader, Bhide
wrote ''The Origin and
Evolution of Small Businesses,'' on the nature of promising start-ups
and their evolution into successful businesses.
The effects of accident and personality can be found on every
page - as well as a salutary taste for
business journalism and memoirs. ''The theory of the firm has
little room for company picnics (an
account of which takes up two pages in Hewlett-Packard's `The
H-P Way,') Sam Walton's hula
dances, hiring practices that trade off talent for personality
`fit,' or unilateral gift-giving to firm
members to create reciprocal obligations and loyalty,'' he writes.
Yet such personal touches are often
hallmarks of success.
There are some questions these books can't answer - such as when
the efflorescence of which they
are a part will fade and give way to some new investing enthusiasm.
Bhide's book, in particular, is a
reminder that it was not always thus. In the 1950s and 1960s,
for instance, the conventional wisdom
was that giant corporations were required to bring new businesses
Indeed, the Treasury Department's decision to pay down the national
debt over the next 13 years by
purchasing $3.6 trillion in government obligations now held by
private investors may fundamentally
change the calculus.
What happens to the risky end of the investment pool when the
least risky, most liquid end
disappears? It's one more reason to expect private equity is
here to stay.