The History and Future of Private Equity

Credit and Direct Equity Investments Ruled

(1600 - 1946)

In the beginning, there was credit.

For most of known history, ventures of all sorts were primarily funded through the extension of credit. Regulations protecting equity investors were sparse, unenforceable, and an investor could never truly know where a business stood financially. The invention of the cash register in 1879, in Dayton, Ohio, helped give some assurances. But not enough to give confidence to investors that their capital, and share of profits, wasn’t being embezzled or otherwise misused. Credit overcame many of these challenges.

For much of this period, the legal doctrine of limited liability did not exist. Investors bore personal risk for business obligations, making equity investments exceptionally risky. New York’s adoption of limited liability in 1811 was a watershed moment and a major reason the city became a global commercial center. Britain, then the world’s economic leader, didn’t follow until 1854.

This lack of liability protection meant that business failures could ruin not just entrepreneurs, but passive investors as well. Equity deals were thus largely limited to family, close associates, or insiders, those willing to trust beyond the legal system. Debtors' prisons, still active in many parts of Europe and North America in the early 19th century, only further cemented credit’s dominance.

Direct Equity Investments

Shipping was one of the handful of industries which received direct equity investments prior to the advent of limited liability being codified. One of the biggest companies in that category was the Dutch East India company. Ships carrying goods to and from far away destinations, were funded by selling share certificates to equity investors. When the ship returned, the profits would be distributed to the investors on a pro rata basis. If the ship didn’t return, the investors lost their investment and had no recourse.

The advent of limited liability made possible the creation of a deeper and wider equity investor market. These early equity investments remained almost exclusively in the domain of the ultra-wealthy. One exception was the railway investment frenzy in Britain in the 1840s, where retail investors participated heavily. Railway investments were seen as safe because of the underlying land and equipment which secured the investments.

By the early 20th century, equity issuances had expanded. Railways, utilities, and department stores began raising capital through public markets. But these were still considered “safe” investments, equity risk as we understand it today was tolerated only when hard assets or strong cash flow offered perceived security.

Venture Capital Fills a Gap

(1946 - 1981)

Following the Second World War, America’s challenge was to convert a war machine economy into a consumer goods economy. The financing frameworks of the day simply weren’t sufficient to fund this societal shift. The ultra-rich were too few and with too little capital. The retail investors could only be relied on to fund established businesses, which wasn’t what was required.

Venture capital, a subset of the private equity asset class, emerged and filled the funding gap. Venture capital funds permitted the pooling of risk capital from many sources. This capital was patient and prepared to take the types of bets the economy needed at that time. Many investors could contribute a portion of the total capital raised, and the scale achieved meant a team of professional money managers could be hired to allocate the capital to the most worthy ventures, and stick around long enough to achieve exits.

The first modern venture capital fund was formed in 1946 and was called the American Research & Development Corporation (“ARD”). It raised a sizable fund and was judged to be a success given one of its portfolio company exits. That exit occurred in 1957, and in today’s dollars would have been valued at $355 million, representing a return of 500 times the initial investment and an annualized rate of return of 101%.

Funding for the early venture capital funds came from wealthy individuals, other technology companies and the military-industrial complex. Pension funds only invested later, when in 1978, the Department of Labor changed its rules and permitted retirement funds to invest in private equity.

Leveraged Buyouts

(1982 - 1993)

In the 1980s, the rise of leveraged buyouts (LBOs) transformed the investment landscape. LBOs involved the acquisition of a company using large amounts of debt, often secured by the very assets of the company being acquired. The remainder of financing typically came from high-yield (“junk”) bonds.

The idea wasn’t just financial engineering—it was grounded in theory. Modigliani and Miller had won a Nobel Prize by demonstrating that capital structure could affect firm value. In practice, the two key advantages were:

1. Leverage-enhanced returns: Equity holders gained everything above what was owed to creditors.

   
   

2. Tax shield: Interest on debt was tax-deductible, reducing taxable income and effectively subsidizing returns.

At its peak, the LBO craze saw deals like the 1989 RJR Nabisco takeover by KKR, valued at $31 billion (over $75 billion in today’s dollars). Many over-leveraged firms collapsed under debt burdens, prompting regulatory scrutiny and a public backlash. “Poison pill” defenses were developed by corporate boards to fend off hostile takeovers, and LBOs temporarily fell out of favor. The 1987 movie, Wall Street, describes well how the industry was perceived and what had to be overcome from a PR standpoint for the asset class to emerge again.

Private Equity Rises From the Dead

(1993 - 2007)

After a brief hibernation, private equity came roaring back. In 1992, PE firms raised $20.8 billion. By 2000, that number had exploded to $305.7 billion. Favorable macroeconomic conditions, strong equity markets, and a resurgent reputation underpinned the comeback.

Venture capital continued to zoom to new heights, only to be humbled, temporarily, by the tech bubble burst. Between 2001 and 2003, average valuations in the VC space were halved. LBO activity also slowed. In 2001, for the first time, Europe had more LBO transaction volume than the U.S concluding when it concluded $44 billion of deals, compared to the American's who closed $10.7 billion.

The LBO industry was given a lifeline in 2002 with the passage of Sarbanes Oxley (SOX). The bill was partially aimed at increasing scrutiny on public companies following Enron and WorldCom scandals. SOX made public company compliance more onerous, boosting demand for privatization. PE firms seized the moment, facilitating take-privates of listed firms, especially in tech. Enormous LBO deals were concluded during this period.

Private Equity Owns the World

(2008 - Today)

Today, private equity’s main problem is they it now own most of the world. It's dominance is so complete that its own success has created scarcity. The pool of viable acquisition targets, particularly large, undervalued firms, has shrunk considerably. This saturation has fueled a shift toward niche strategies and thematic fads, like the data center rush between 2017 and 2022, where over $70 billion was deployed globally, often at unsustainable valuations

LPs increasingly complain about fee structures (the traditional “2 and 20”), misalignment of incentives, and disappointing net returns. Yet capital commitments continue to flow. In 2023 alone, global PE fundraising topped $850 billion. The wheels are in motion to replace a portion of any fatigued LPs with smaller individual retail investors. Blackstone, KKR, and Apollo have all launched retail-focused vehicles to tap the high-net-worth and mass affluent segments. With over $20 trillion in U.S. retirement assets, the opportunity is vast, but so are the regulatory and reputational risks.