How did Megafunds become Megafunds?

technocrat's picture
Rank: Baboon | 164

What's up yall. I have a question for you finance-history nerds.

Raising billions upon billions of dollars is hard, to say the least. Super successful tech founders struggle to raise tens of millions to start a VC fund, super successful traders struggle to raise hundreds of millions to start a hedge fund, etc.

How in tarnation did guys like Schwartzman and Kravis raise such large sums of money in the early days of PE (without a proven track record)?

Comments (12)

Most Helpful
May 29, 2018

Their first funds weren't huge and they performed extremely well. Then, since they were early to the LBO party, they were some of the only people with track records doing LBO's and thus were able to attract a lot of capital. Basically, they were early to the party and they performed well.

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May 29, 2018

If you look at KKR's 10-K, it shows that their first fund in 1976 was $31.4 million of committed capital. The Gross Multiple of Invested Capital on that first fund was 17.1x. The next fund they raised in 1980 was then $356.8 million of committed capital. In short, that is how they got to where they are in terms of raising capital.

May 30, 2018

by making money for investors

May 30, 2018

There's a video somewhere about Schwarzman talking about how hard it was to raise capital for their first fund. They went on numerous pitches and got zilch. They went to Prudential and as he was pitching, the guy was eating a tuna fish sandwich and Schwarzman said that the only thing he could think about was hoping that the guy didn't choke on his sandwich. Eventually the guy agreed to fund them and all the papers were signed coincidentally a day or two before the Black Monday crash. Probably wouldn't have been funded if the timeline was only slightly delayed.

May 30, 2018

If you have the time to pick up a new book, check out King of Capital. Really good read on Schwarzman and Blackstone's growth from inception to IPO.

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May 30, 2018

Was just about to post this, King of Capital provides a great history of BX but also LBOs in general

Also, read "Merchants of Debt"
Its like the same thing, but for KKR

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May 30, 2018

Awesome. Barbarians gives a bit of an overview of KKR's inception, but would love a more comprehensive read.

Just started reading The Quants... 2nd and 3rd chapter details the birth of hedge funds in the 60s and onward. Super interesting to learn about the birth of modern institutional investing.

Apparently the first institutional investor (mostly debt) was the either the Buddhist or Confucian Church of china circa 2000 BC. Go figure...

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May 30, 2018

.

May 30, 2018

I agree with the above recommendation to read "King of Capital". However, I will addition it with read "Greed and Glory of Wall Street: The Fall of the House of Lehman" first. It covers when Lehman Brothers had to sell to Shearson/American Express in the 1980's and it covers a lot of the players that are in "King of Capital" / ended up at Blackstone and gives it a great frame of reference.

Going back to your original question regarding how the megafunds ended up where they are today:
1. As mentioned above, they were the first ones to the party and did very well
2. Drexel Burnham & Michael Milken had just created and commercialized the junk bond, which was able to fund the party. Investors were more than willing to supply, allowing for the 3-10% equity stakes firms were putting up to purchase companies and borrowing the rest (which partially lead to the credit squeeze & crash of 1987). The fact that interest rates peaked around 1980 - with volatility here and there during recessions- and generally fell until the 2000s also helps the economics of an LBO.
3. In the 1960's, the business model was conglomeration: massive companies would acquire different lines of business in an effort to diversify, so if one industry hit a slow down, it wouldn't squeeze the entire organization. This led to inefficiency, and then when companies started to pare down their business lines, strong core businesses that just ran inefficiently were now available for PE firms to come, buy, clean up and profit. This magnified why being the first to the party was so advantageous.

All of that is from reading King of Capital a few weeks ago: I cannot recommend that book more. I think that should provide some color and hopefully inspire to learn more.

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May 31, 2018
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