It is not the critic who counts; not the man who points out how the strong man stumbles or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.

—Theodore Roosevelt, “Citizenship in a Republic”

Two percent in annual fees. Twenty percent of the profits. These are the fees private equity firms charge investors to manage and invest their money. The firms earn fees for running the cash they are entrusted with, and they also earn a share of the resulting profits from investments. This “Two and Twenty” formula sits at the core of the private equity industry, and although there are variations of it across firms and funds, it is the industry benchmark. It’s an incentive that has helped create tremendous wealth for these dealmakers, while aligning the objectives of those who take the risk to put up the capital and those who seek to make profits from it on their behalf. In the simplest terms, the more money the investors make, the more the professionals make. They can both win together.

Today, private equity—in combination with other forms of private capital—is a $12 trillion industry.[*] It doubled in size during the 2010s, and by the end of this decade, it could well exceed $20 trillion. At the most basic level, what private equity does is invest money into an operating enterprise, a real business (or business plan) that needs to be fixed or that requires capital to grow, and then improve it before exiting at a profit. Put like that, it sounds simple. Private equity professionals pierce the veil, going beyond merely weighing the pros and cons of trading securities to understanding the workings of the underlying enterprise itself, just like a good company CEO would. Moreover, through the size of their investments, typically a controlling stake, private equity firms act like engaged owners, not passive investors. They eat what they cook. And that makes all the difference.

We cannot overestimate the reach of private equity across the global economy at this point. It is present nearly everywhere, in sectors as diverse as chemicals, energy and power, banks and insurance, consumer and retail, aerospace and government, manufacturing and industrials, media and telecommunications, leisure and entertainment, healthcare and pharmaceuticals, and technology. It has invested in subsectors we might not think of as natural habitats for Wall Street, from our children’s schools to food storage to dating applications to family-ancestry tracing to military and intelligence technology. The vehicles used to make these investments are dizzying in their variety, from the traditional private equity funds that raise capital once and draw down commitments as required, to publicly listed funds, to the burgeoning class of funds that keep going without a finite life (so-called “permanent” or “perpetual” capital), to special-purpose vehicles funded on a one-off basis by pension funds and other investors or the balance sheets of private equity firms. There are hundreds of established private equity firms and hundreds more newer ones behind them. New firms crop up every year or two. At the apex of the industry sit a dozen major firms, the biggest of which are publicly listed, such as Blackstone and its rivals Carlyle and KKR. It’s all too easy to get lost in the maze.

Blackstone manages over $875 billion in assets across investment strategies. Some firms are open about their desire to manage over a trillion dollars in assets themselves within just a few years. Taken together, the largest publicly listed firms manage over $2.5 trillion in assets. And even though the size of funds under management seems enormous, it underestimates the purchasing power of each firm, because of the multiplier effect of leverage. Money that is put to work in private equity funds can be leveraged by the debt raised on top of it to make investments. The unspent money in private equity funds, “dry powder” as we call it, can be multiplied by adding debt on top when investments are made. Take a relatively small fund, totaling $1 billion, and add $3 billion of debt. You now have $4 billion of purchasing power. Now consider not just private equity but all forms of private capital managed by private equity firms that can have debt raised on top of the money invested from the funds. That’s trillions of dollars to invest.

Within our children’s lifetimes, the industry could well be managing tens of trillions of dollars in assets. The field is huge and lucrative and has its fingers in nearly every sector of the economy, and yet the average person scarcely thinks about it—or would be able to explain how the industry works. Consider this: When we talk about private equity capital, we are, to a substantial extent, referring to money that belongs to the retirees of tomorrow. We are talking about individuals who rely—via their pension fund managers—on an industry they probably don’t understand very well to deliver the returns they will need to live off in old age. We are talking about tens of millions of workers—employees like teachers, firefighters, and other pensioners around the world.

The rise of private equity has been hiding in plain sight. The industry doesn’t mint the kind of high-publicity executives you find in “big tech” companies like Amazon or Tesla or Apple. But its reach is staggering. Investors turn to private equity to deliver higher, more consistent returns that are hard to get elsewhere. And as private equity firms introduce other strategies, such as credit, real estate, and infrastructure, these investors allocate money to those strategies too. The largest firms have become one-stop shops for alternative investments. Yet few outside Wall Street think much about them.

This knowledge asymmetry needs to change. It’s time for people to learn what’s really going on with private equity, to get to know the traits and motivations of the key people pulling the strings. That’s where this book comes in.

We are all well conditioned to think about, talk about, and obsess about the “big banks” of Wall Street that were deeply involved in the chaos of the financial crisis of 2007–8. We are fixated with the “big tech” of Silicon Valley and its drumbeat of IPOs, not only because of those companies’ insinuation into our daily lives but also due to the astronomical wealth that successful technology companies generate. Everyone with a 401(k) knows the alphabet soup of acronyms that cover names like Apple, Microsoft, Amazon, and Google. They know their retirement income relies on them. What about private equity? We know little about the handful of masters who control it or the people who work for them. This elite slice of society, with its strengthening grip on pensioners’ money, has yet to be firmly established in the everyday lexicon. My goal in writing this book is to reveal the traits, culture, and temperament that fuel the most successful practitioners of Two and Twenty.

Two and Twenty as a fee concept is de rigueur across the industry, but there are striking differences in investment performance across private equity funds and firms. Even if the promised financial rewards are the same, some firms are able to consistently generate investment returns above what the mutual or index or exchange-traded fund (ETF) industries can provide far more cheaply, whereas others, over time, are beaten by the S&P 500 index of leading U.S. stocks. It is more than simply the promise of big payouts to investment professionals that makes many private equity firms excel and deliver excess returns for investors.

In the past two decades, private equity has supplanted investment banks and hedge funds in its allure—it’s where the most talented young minds in finance go to make their mark. This is a people business, and the magic behind its success partly lies in how these people act and organize themselves to win. It’s the individuals involved in private equity, their micro interactions, framed by the macro culture of the firms they work in. What drives a winning mindset is environment plus drive. In the chapters that follow, I will explore their motivations and the impact of their ambitions and beliefs on the deals they work on, the partnerships they create with the management teams in portfolio businesses invested in, and other stakeholders. When things go wrong, how and why does this happen? And what’s the fix? I’ll reveal that too.

By looking under the hood of private equity—and understanding the mindset of the folks involved—readers will better grasp why some funds (and firms) are more likely to work out than others. Whether you are a young person contemplating a career in private equity, a seasoned professional, or an armchair investor, this book will, I hope, both inform and entertain. My goal is to arm you with the knowledge and insights you will need to navigate and better understand one of the business world’s largest, fastest-growing, most influential, and most opaque realms.

Why should you trust me to be a guide through this maze? Trying to divine the dealmaking motivations within private equity is a tall order for most outside observers of the industry, even those with aspirations to work in private equity or with business and financial acumen. I have worked in this industry for twenty-five years, first as an investment banker and then as an investor at one of the major firms at the partner level. I am hugely supportive of this industry and invest actively in it across the major firms—for my own account. I am your insider, but I am also independent. I’m not interested in spin or corporate talk. I call it like it is.

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In these pages, I’ve tried to plot a course through the substance behind Two and Twenty, going beyond the headlines about how many billionaires and multimillionaires the private equity industry has minted or how much tax they should be paying or what their personal conduct in or out of the office is like. My focus is the business, the dealmaking, what I have learned from the successful investment professionals I have known who have originated and executed the deals that beat the stock market, time and time again. They are the industry elite, and they got there because they keep on delivering for investors.

In each chapter that follows, I will explore a different facet of the private equity mindset, using fictitious sketches, putting events and interactions under the microscope to explore what they reveal about what working in private equity at the senior level is really like. Some of these sketches are inspired by real-life deals and events, ones that have stuck in my mind for good reason, but I have masked or changed certain details that need to remain private and are not relevant to the important themes at play. As I relate these sketches, my goal is to focus on the stories that these investments tell and extract the vital lessons that make them worth recounting.

The principles I highlight will add up to a kind of playbook: a guide to being successful working in private equity. It’s these patterns of behavior that animate and breathe life into what is increasingly a fundamental part of our economic system—an industry that should be better understood, as it continues to play a vital role in our financial health.

I’m well aware that the words “private equity” can connote very good things for some and engender distaste in others. While my hope is to add positivity to the conversation about private capital, I’ve endeavored, as I look into the mirror of my industry, to always stay rational—and to tell it to you straight, warts and all.

I hope that, by the time you turn the final page, you will have gotten a vivid portrait of an industry I love being a part of—and that you will have gained a greater understanding of the increasingly major role this industry plays, globally, in funding society.

We stand a much better chance of improving what we understand

Contents

Cover

Title Page

Copyright

Epigraph

Preface

Chapter One: The Best Game in Town

Chapter Two: We Don’t Sell Plain Vanilla

Chapter Three: Behind the Curtain

Chapter Four: We Eat Our Own Cooking

Chapter Five: Running into a Burning Building

Chapter Six: There Is No Formula

Chapter Seven: Never React, Always Respond

Chapter Eight: If You Don’t Ask, You Don’t Win

Chapter Nine: How to Make More

Chapter Ten: Desperation, Not Hunger

Chapter Eleven: The Library

Chapter Twelve: Stack the Deck

Chapter Thirteen: The Edge

Conclusion: The Age of Big Finance

Dedication

Acknowledgments

An Everyday Private Equity Glossary

About the Author