Wharton Journal

Issue date: 2/19/07 Section: News

Tim Draper, founder of venture capital firm Draper Fisher Jurvetson, opened the 2007 Wharton Private Equity & Venture Capital Conference with a song and dance. Literally. But before his performance he gave an inspiring keynote speech with his main message being for us to go out and change the world. "About half of you are from the Wharton Business School... well that's an amazing business school and so you do have the ability to make enormous change, have an enormous impact on the world. And I think with that kind of an education, it's almost your responsibility to go out there and do something really extraordinary for the world and so, go do it."

Following Mr. Draper, Stephen Schwarzman, co-founder of the private equity firm Blackstone Group, gave Wharton conference attendees a sneak preview of the talk he would give one week later in Davos, Switzerland at the World Economic Forum. He cited three key reasons for the recent explosion in the private equity industry and the constant media attention his industry has been receiving of late.

First, private equity has been the best performing asset class over the past thirty years and that has attracted huge amounts of investor capital from pension funds and endowment funds. This, in turn, has enabled firms like Blackstone to double or triple the size of their funds; Blackstone expects to close its latest fund at $20 billion.

Second, the cost of capital for private equity firms is extremely low because the risk premium for lending has virtually disappeared. In addition, because banks are syndicating a majority of their loans in buyout transactions (80% today versus only 20% ten years ago), they are not requiring strict covenants, which is enabling private equity firms to be even more aggressive in their use of leverage (i.e. it is hard to go bankrupt when you have no covenants).

Finally, structural changes in the corporate world, starting with the Sarbanes-Oxley regulation, have made compliance onerous. So much so that board of director focus has shifted away from running and growing their businesses. The pressures of meeting quarterly earnings targets inhibit CEOs from making optimal long-term business decisions. Going private enables these companies to refocus on their business, reinvent their business model and restructure operations without worrying about missing quarterly earnings. When they re-enter the public markets (because private equity firms ultimately need to exit their investments) they emerge stronger and better positioned for the long-run.

Continued...

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