Author: Gert-Tom Draisma / www.TristanFinance.com

First published: 24th of September 2026

Latest update: 28th of September 2026

Part I — The Development of Private Equity

2. Private investment before “private equity”

The history of private equity did not begin with private equity firms.

It did not begin with leveraged buyouts, venture capital partnerships or even with the modern corporation. In an important sense, private investment is much older than public investment. For most of commercial history, businesses were privately owned because organised public capital markets either did not exist or were available only to a very limited number of enterprises.

The economic problem at the heart of private equity is therefore ancient.

Someone has capital.

Someone else has an idea, an opportunity, a business, a particular expertise or the ability to undertake a commercial venture.

Capital must somehow be brought together with entrepreneurial capability, and the parties must agree how the risks and eventual rewards will be divided.

Long before anyone spoke of general partners, limited partners, management fees or carried interest, merchants and financiers were solving variations of precisely this problem.

Capital, risk and the earliest commercial ventures

Long-distance maritime commerce provides a particularly useful historical analogy.

A commercial expedition could require substantial amounts of capital before a ship left port. Ships had to be acquired or chartered. Crews had to be hired and paid. Supplies had to be purchased. Goods had to be obtained for trade. Insurance or other risk-sharing arrangements might be required.

The outcome was uncertain.

A successful voyage could generate considerable profits. An unsuccessful one could result in the loss of cargo, vessel and capital.

Most importantly, the capital could be tied up for a considerable period.

The investor could not ask for the money back when the ship was halfway to Asia. Nor was there necessarily a ready market in which an interest in the voyage could be sold.

The capital was committed to the venture.

Several economic ingredients that later became central to private equity were therefore already present:

capital provided by outside investors;
entrepreneurs or specialist managers deploying that capital;
uncertainty over the eventual outcome;
significant information asymmetry;
an extended period before the investment could be realised;
limited liquidity;
and some arrangement for dividing the resulting profits.

This does not mean that a seventeenth-century trading voyage was a private equity fund in the modern sense. It clearly was not. The legal institutions, financial instruments and economic environment were entirely different.

But the underlying economic relationship is recognisable.

Capital and specialist capability do not necessarily reside with the same person.

That observation is particularly relevant to the subject of this Bible because the historical origins of the expression carried interest itself are often associated with older forms of profit participation in commercial ventures. We will return to that history separately.

For the moment, the more important point is that private equity belongs to a much longer history of investors entrusting capital to people who claim to be able to employ it productively.

3. From family capital to organised finance

For centuries, much of the capital available to private businesses came from founders, families, wealthy merchants, banks and informal networks of investors.

Industrialisation greatly increased the scale of the problem.

Building railways, steel mills, mines, factories, telegraph systems and other industrial enterprises required amounts of capital far beyond those needed by most earlier businesses. Banking systems developed, securities markets expanded and the modern corporation gradually emerged as an increasingly important mechanism for aggregating capital.

Public equity markets solved part of the problem.

A business could divide its ownership into shares. Those shares could be held by many investors and, if listed on an organised exchange, could subsequently be bought and sold.

This introduced something extraordinarily important into finance:

liquidity.

An investor no longer necessarily had to remain invested until the underlying enterprise was sold or liquidated. The investor could sell the security to another investor.

That distinction eventually became one of the defining differences between public and private investment.

But public markets did not eliminate private capital.

Many businesses were too small to access them. Others were too young, too risky or too unusual. Families and entrepreneurs frequently preferred to retain control. Companies in financial difficulty might require investors willing to accept risks that conventional lenders would not.

Wealthy families therefore continued to provide what today might be recognised as private risk capital.

In the United States, families associated with great industrial fortunes—including the Rockefellers, Whitneys and others—invested in new enterprises during the first half of the twentieth century. Harvard Business School's historical account of the development of venture capital notes that wealthy family funds supplied much of the private-company investment capital before the emergence of institutional venture organisations.

The investments themselves could be highly sophisticated.

What had not yet fully emerged was the institutional intermediary that would collect capital from multiple unrelated investors and deploy it professionally across a portfolio of private companies.

That development accelerated after the Second World War.

4. The Second World War and the origins of modern venture capital

The Second World War produced extraordinary technological development.

Radar, aviation, electronics, communications, materials science and many other technologies advanced rapidly under the pressure of wartime necessity.

When the war ended, the United States possessed not only enormous industrial capacity but also a generation of scientists, engineers and managers who had participated in an unprecedented mobilisation of technology.

There was, however, a financing problem.

Banks were principally lenders.

A bank could lend against assets, established revenues and reasonably predictable cash flows.

An entrepreneur attempting to commercialise a new technology might possess none of those things.

The entrepreneur might have knowledge.

A prototype.

Intellectual property.

An idea.

Perhaps a small group of engineers.

But there might be little collateral against which a conventional loan could safely be made.

Nor were public equity markets a practical financing source for most such companies.

A different form of capital was required: capital capable of accepting substantial uncertainty, remaining invested for years and participating in the upside if the enterprise succeeded.

This was the environment in which modern venture capital began to emerge.

5. Georges Doriot and American Research and Development Corporation

One of the most important figures in this development was Georges F. Doriot.

Born in France in 1899, Doriot became a professor at Harvard Business School and later served in the US Army during the Second World War, eventually reaching the rank of brigadier general. His wartime responsibilities exposed him directly to the relationship between scientific innovation, industrial capability and practical application.

After the war, Doriot became central to an experiment that would have consequences far beyond Boston.

In 1946, American Research and Development Corporation, usually known as ARD, was established in Massachusetts.

ARD is important not because nobody had previously invested private capital in entrepreneurial companies. Wealthy individuals and families had been doing so for generations.

Its importance lay in the attempt to institutionalise the activity.

Harvard's Baker Library describes ARD as one of the first modern venture-capital companies and, importantly, as an early vehicle that provided private equity from capital outside traditional family fortunes. It combined financial resources with managerial support for entrepreneurs.

That was a significant conceptual development.

Instead of private-company investing being primarily an activity undertaken by wealthy families with their own money, it could become a professional investment activity undertaken by specialists on behalf of outside capital.

Doriot's conception of the investor was also unusual.

He did not see investment merely as purchasing a security and waiting for its price to rise.

The investor could participate in building the enterprise.

Capital could be combined with governance, advice, networks, recruitment, patience and judgement.

Harvard's historical research on ARD emphasises that governance was part of the organisation's purpose from its beginning.

This idea—that the investment manager might actively influence the development of the company rather than simply provide money—would become one of the recurring themes of private equity.

6. Digital Equipment Corporation: the investment that proved the model

Every emerging investment industry eventually acquires stories that demonstrate what is possible.

For ARD, that investment was Digital Equipment Corporation, or DEC.

In 1957, Kenneth Olsen and Harlan Anderson, engineers associated with MIT's Lincoln Laboratory, approached ARD with plans for a new computer business.

Computers at the time were enormous and extraordinarily expensive machines. Olsen and Anderson envisaged smaller and less expensive systems.

Their proposal was risky.

The company did not have decades of financial statements.

It did not possess the type of collateral upon which conventional lending was based.

Its value depended substantially upon technology that had yet to be commercialised and people who had yet to demonstrate that they could build a major company.

This was precisely the type of financing problem that venture capital was intended to solve.

ARD provided $70,000 of equity financing in return for a 70 percent interest and also provided a $30,000 loan. The transaction took place in 1957—a date confirmed by Baker Library's archival history and the surviving proposals from Olsen and Anderson.

DEC began in an old woollen mill in Maynard, Massachusetts.

What followed became one of the defining success stories of early venture capital.

DEC developed into a major computer manufacturer and ultimately became the dominant company in the minicomputer industry, at one point ranking behind only IBM among computer manufacturers.

But the importance of DEC to the development of private equity lies in more than the magnitude of ARD's eventual return.

The investment demonstrated several propositions simultaneously.

First, specialist investors could identify opportunities that conventional finance found difficult to support.

Second, a relatively small initial investment could participate in enormous value creation if the underlying company succeeded.

Third, the investment might need to be held for a long time.

And fourth, the investor could contribute more than capital.

Ken Olsen later recalled that ARD resisted opportunities to sell the company prematurely. Doriot's philosophy was to build companies rather than automatically realise the investment at the first profitable opportunity.

That idea sounds strikingly modern.

Private capital was not merely financing innovation.

It was becoming a form of long-term ownership.

7. The SBIC programme and the broadening of risk capital

ARD demonstrated one possible institutional model, but the supply of venture capital remained limited.

Government policy also became important.

In 1958, the United States adopted the Small Business Investment Act, establishing the Small Business Investment Company, or SBIC, programme.

The objective was to increase the availability of long-term capital to smaller businesses.

Private organisations meeting the programme's requirements could obtain access to government-supported leverage and use that financing, together with private capital, to invest in qualifying businesses.

The programme was not identical to the venture-capital model that later became dominant. Nevertheless, it helped broaden the infrastructure surrounding professionally managed private investment.

It also reinforced an important concept:

Private risk capital could be organised through specialist investment entities rather than supplied exclusively through direct relationships between wealthy individuals and entrepreneurs.

The foundations of an industry were gradually being constructed.

8. The West Coast and the emergence of Silicon Valley

The early institutional venture-capital story had strong roots in Boston and the technology corridor around Route 128.

But the centre of gravity of American venture capital would increasingly move west.

California possessed an unusual combination of ingredients.

Stanford University provided scientific talent and maintained unusually close relationships with industry.

The defence and aerospace sectors generated advanced technologies and experienced engineers.

Semiconductor development created new businesses and new generations of entrepreneurs.

Employees who succeeded at one technology company left to establish others.

Capital followed talent, and talent followed capital.

The result was the ecosystem that became known as Silicon Valley.

Fairchild Semiconductor became particularly important.

Founded in 1957 by engineers who had left Shockley Semiconductor Laboratory, Fairchild became a remarkable source of both technology and entrepreneurial talent. Companies created by former Fairchild employees helped populate the emerging semiconductor industry.

This produced something that would become characteristic of successful venture ecosystems: recycling.

Successful entrepreneurs became investors.

Successful investors backed new entrepreneurs.

Employees acquired equity, became wealthy and financed new businesses.

Lawyers, recruiters, accountants and advisers developed specialist knowledge.

Universities supplied talent.

Customers and suppliers clustered geographically.

Venture capital therefore became more than a source of money.

It became part of an ecosystem.

9. The partnership model emerges

The organisational structure of venture investing also evolved.

ARD had been organised as a publicly traded closed-end investment company.

That structure had disadvantages.

As the industry developed, specialist investment firms increasingly adopted the limited partnership.

The structure was well suited to private investment.

Outside investors could commit capital as limited partners.

A specialist investment manager, acting through the general partner, could select and manage the investments.

The vehicle could have a finite life.

Capital could be drawn when investments were made rather than necessarily being invested immediately.

Profits could be distributed when investments were realised.

And the manager could participate economically in successful outcomes.

This separation between capital provider and investment specialist would become one of the defining organisational characteristics of private equity.

It also created the economic relationship that sits at the centre of this Bible.

The limited partners supply almost all of the capital.

The general partner decides where that capital should be invested.

The investors therefore face an obvious question:

How should a manager entrusted with somebody else's capital be incentivised to behave as though the capital were its own?

Part of the eventual answer was management fees.

Part was governance.

Part was the manager's own investment in the fund.

And part was a share of investment profits:

carried interest.

The history of private equity and the history of carried interest were beginning to converge.

10. The professionalisation of venture capital

By the late 1960s and early 1970s, venture capital was becoming recognisable as a profession in its own right.

Specialist firms emerged whose primary activity was not banking, securities trading or family investment but investing in young private companies.

In 1972, two firms that would become synonymous with Silicon Valley venture capital were established: Kleiner Perkins and Sequoia Capital.

Their emergence represented a broader transition.

The venture capitalist was becoming a distinct professional figure.

The job required the ability to identify markets that did not yet fully exist, assess technologies that might fail, evaluate founders without decades of management history and construct portfolios in which some investments could fail completely while a small number of extraordinary successes generated much of the overall return.

That model differed substantially from conventional lending.

It also differed from public equity investing.

The venture capitalist was investing before much of the information that a conventional securities analyst would normally expect to see even existed.

The uncertainty was therefore enormous.

But so was the potential upside.

The extraordinary growth of the semiconductor and computer industries, followed eventually by biotechnology and software, demonstrated the economic potential of the model.

Private equity's first great institutional success was therefore not the leveraged buyout.

It was venture capital.

11. A second branch develops: acquiring established companies

At approximately the same time, another form of private investment was developing.

Venture capital addressed one particular financing problem: how to provide risk capital to businesses whose future potential was substantial but whose current assets and cash flows might be limited.

Established companies presented a different opportunity.

They already had:

products;
employees;
customers;
assets;
revenues;
and, importantly, cash flows.

Those cash flows could support borrowing.

That meant an investor did not necessarily have to provide the entire acquisition price as equity.

Part could be financed with debt.

The acquired company could then use its future cash flows to service and eventually repay that debt.

This was the basic economic foundation of the leveraged buyout.

The technique was not invented suddenly in the 1980s.

Transactions resembling leveraged buyouts had existed much earlier.

What changed during the 1960s and 1970s was the increasing sophistication with which specialist investors applied the technique and the beginnings of an industry organised around doing so repeatedly.

12. Jerome Kohlberg and the early buyout model

One of the important pioneers was Jerome Kohlberg Jr.

While working at Bear Stearns, Kohlberg became involved in what were then often described as “bootstrap” acquisitions.

A common situation involved a family-controlled business whose founder wished to retire.

The company might be profitable and generate substantial cash, but the next generation might not wish to take over.

Management might want to acquire the business but lack sufficient capital.

A transaction could be structured in which management and outside investors contributed equity while borrowing financed a substantial part of the purchase price.

The cash flows of the business helped repay the acquisition debt.

This was recognisably the ancestor of the modern management buyout.

Henry Kravis and George Roberts subsequently worked with Kohlberg at Bear Stearns.

The three developed an approach centred on acquiring companies, working with management and holding the investments for periods considerably longer than the trading mentality prevalent in much of Wall Street.

Kravis later described the philosophy as thinking about what a company should look like many years into the future rather than seeking a quick trading profit.

This distinction was important.

The investor was not merely purchasing securities.

The investor was acquiring companies.

13. The founding of KKR

In 1976, Jerome Kohlberg, Henry Kravis and George Roberts left Bear Stearns and established Kohlberg Kravis Roberts & Co., better known as KKR.

The firm began modestly.

According to KKR's own history, the founders initially struggled to find companies to acquire. There was no electronic database of potential targets and no established private-equity deal infrastructure. Finding investments could involve literally approaching businesses and their management teams directly.

That observation is worth remembering when looking at today's enormous private-markets industry.

Private equity did not emerge fully formed.

The pioneers had to develop not merely investment strategies but a market around them.

They had to persuade business owners to sell.

They had to persuade managers to work with them.

They had to persuade lenders to finance transactions.

And they had to persuade investors to provide capital to a relatively unfamiliar investment model.

KKR's first institutional fund, raised in 1978, contained approximately $35 million.

By later private-equity standards, that amount was tiny.

But something much larger was beginning.

14. Carried interest becomes part of the institutional model

KKR's account of its formation is particularly interesting for the purposes of this Bible because it explicitly discusses the question of how the investment professionals themselves should participate in profits.

The founders needed operating income.

But they also wanted to share in successful investment outcomes.

KKR describes adopting a profit-sharing concept that became what the private-equity industry now recognises as carried interest.

The concept was not invented from nothing in 1976; profit participation by investment managers had historical precedents and was already associated with venture-capital partnerships. Nevertheless, its adoption by the developing buyout industry helped establish the economic architecture that would become characteristic of private equity.

The significance is easy to miss.

A private equity manager is not simply an employee receiving a salary for managing a portfolio.

The economic proposition became:

Investors provide the capital.Managers provide investment expertise and undertake the work.If the investments succeed, the managers participate in the resulting profits.

As private equity grew, the apparently simple idea would generate an extraordinary variety of contractual structures.

Preferred returns.

Catch-ups.

Whole-fund waterfalls.

Deal-by-deal waterfalls.

Clawbacks.

Escrows.

Vesting.

Leaver provisions.

Management-company participation.

Carry vehicles.

Tax structures.

And eventually the highly sophisticated carried-interest arrangements examined throughout this Bible.

But the basic economic proposition was already visible in the industry's early development.

15. Pension funds arrive

Perhaps the most important step in transforming private equity from an entrepreneurial financial activity into an institutional asset class was the arrival of pension capital.

KKR's experience illustrates the transition.

In 1978, Oregon's public pension system committed $10 million to KKR.

At the time, public pension portfolios were overwhelmingly associated with conventional investments such as listed equities and bonds. Private acquisitions were unfamiliar territory.

KKR describes the Oregon investment as the first alternative investment by a US public pension fund. In 1981, Oregon went considerably further, committing $178 million to KKR's $420 million acquisition of Fred Meyer. Other public pension investors followed.

This changed the industry in two ways.

First, it dramatically expanded the potential supply of capital.

Pension funds controlled pools of assets vastly larger than those available from individual wealthy investors.

Second, it changed the institutional expectations placed upon private equity managers.

A wealthy individual investing personal money can decide for himself what information he requires.

A pension trustee investing retirement assets on behalf of thousands or millions of beneficiaries occupies a different position.

Institutional capital demands institutional processes.

The growth of pension investment therefore helped drive the development of:

formal fund documentation;
investment mandates;
fiduciary standards;
valuation policies;
financial reporting;
audits;
investor reporting;
governance procedures;
performance measurement;
advisory committees;
and increasingly sophisticated contractual protections.

Private equity was becoming an asset class.

16. Regulatory change and the expansion of institutional capital

The late 1970s also brought an important shift in the regulatory environment surrounding US pension investment.

The Employee Retirement Income Security Act of 1974—ERISA—had established standards governing private pension plans. Initially, uncertainty surrounding the prudent-man requirements contributed to caution toward higher-risk investments.

Regulatory clarification toward the end of the decade increasingly emphasised prudence at the portfolio level rather than requiring every individual investment to appear conservative in isolation.

That mattered for venture capital and private equity.

An investment could be individually risky while still forming a rational part of a diversified institutional portfolio.

This conceptual change helped make it easier for pension investors to consider alternative assets.

The consequences extended far beyond the United States.

Over subsequent decades, pension funds, endowments, foundations, insurance companies, sovereign wealth funds and eventually other classes of investor would become fundamental suppliers of private-market capital.

The GP-LP model now had access to enormous pools of long-duration institutional money.

17. The 1980s: private equity discovers scale

The 1980s transformed leveraged buyouts.

What had largely been a specialised technique for acquiring relatively modest companies became capable of taking some of America's largest corporations private.

Several developments made this possible.

Institutional equity capital became more available.

Banks became increasingly comfortable financing acquisitions.

Investment banks developed specialist merger and acquisition capabilities.

The market for below-investment-grade corporate debt expanded rapidly.

Management teams became familiar with buyouts.

Corporate conglomerates created opportunities for divestitures and break-ups.

And a growing group of specialist buyout firms competed for transactions.

Most importantly, the financing market changed.

18. Michael Milken, Drexel and the high-yield market

The development of the high-yield bond market is inseparable from the history of the 1980s buyout boom.

Below-investment-grade corporate bonds had existed before the decade, but Michael Milken and Drexel Burnham Lambert helped create a much larger and more liquid market for newly issued high-yield securities.

These instruments became popularly known as junk bonds.

The name was unflattering, but the economic innovation was significant.

Acquisition financing had traditionally depended heavily upon banks and other lenders prepared to make loans against the assets and cash flows of the target.

The expanding high-yield market provided another source of enormous quantities of debt capital.

A buyout sponsor could combine:

equity;
bank loans;
subordinated financing;
and high-yield bonds

to assemble financing packages capable of acquiring companies far larger than the sponsor's equity fund alone could purchase.

The implications were profound.

The potential size of a buyout was no longer determined simply by how much equity a sponsor had raised.

Debt markets could multiply the purchasing power of that equity.

The leveraged buyout moved into the corporate mainstream.

19. Why corporations became vulnerable to buyouts

The buyout boom was not simply a story about abundant debt.

It also reflected dissatisfaction with the way some large American corporations were managed.

During previous decades, conglomerates had become common.

Companies acquired businesses in unrelated industries.

Corporate headquarters could become large.

Management sometimes controlled substantial resources despite owning relatively little of the company's equity.

Critics argued that this separation between ownership and control created inefficient capital allocation and weak accountability.

A company might own valuable divisions whose combined value exceeded the market value assigned to the conglomerate as a whole.

Cash-generative businesses might subsidise poorly performing operations.

Management might pursue size rather than shareholder returns.

The leveraged buyout offered one possible response.

Ownership could become concentrated.

Management could be given substantial equity incentives.

Non-core businesses could be sold.

Costs could be scrutinised.

Cash flow could be directed toward debt repayment.

The threat of a takeover itself could place pressure on incumbent management.

To supporters, buyouts were a mechanism for imposing discipline upon complacent corporations.

To critics, they represented aggressive financial engineering, excessive debt and short-term cost cutting.

Both interpretations became part of the political and cultural debate surrounding private equity.

20. From buyout specialists to “corporate raiders”

The distinction between a negotiated private-equity acquisition and a hostile corporate takeover was not always obvious to the public.

The 1980s became the age of the corporate raider.

Figures such as Carl Icahn, T. Boone Pickens and others acquired significant positions in public companies and challenged incumbent management.

Not all were private equity investors in the modern fund sense.

Their strategies and financing differed.

But in the public imagination, hostile takeovers, junk bonds, leveraged buyouts and private investment became part of the same Wall Street phenomenon.

Popular culture reflected the mood.

The fictional Gordon Gekko in the 1987 film Wall Street became a symbol of the era.

The phrase “greed is good” entered popular culture.

Leveraged finance was no longer an obscure corner of corporate finance.

It had become part of a much larger debate about ownership, capitalism, management and the purpose of the corporation.

And then came RJR Nabisco.

21. RJR Nabisco: the deal that came to define an era

Few transactions have influenced the public perception of an entire industry as profoundly as the leveraged buyout of RJR Nabisco.

RJR Nabisco was not an obscure company.

It was one of America's largest corporations, combining the R.J. Reynolds tobacco business with major food brands assembled within Nabisco.

Its chief executive was F. Ross Johnson.

Johnson was charismatic, ambitious and associated with a lavish corporate culture. In 1988, he and a group of advisers developed a proposal for management to acquire the company in a leveraged buyout.

That decision set in motion one of the most extraordinary takeover battles in corporate history.

The proposal immediately raised questions.

Management knew the company better than almost anyone.

If management believed the company could be purchased, restructured and subsequently made considerably more valuable, why had that value not already been created for existing shareholders?

If executives participated financially in the buyout, were their interests aligned with the shareholders they were supposed to represent?

Did management possess information unavailable to competing bidders?

And was the proposed acquisition price fair?

Once the possibility of a buyout became public, the process escaped management's control.

Other bidders emerged.

Most importantly, KKR entered the contest.

22. The battle for RJR Nabisco

The RJR Nabisco contest became an auction conducted on an unprecedented scale.

Teams of investment bankers, lawyers and financing specialists worked under enormous pressure.

Each bidder had to determine not merely what the company was worth, but how an acquisition of extraordinary size could actually be financed.

The numbers escalated.

Every increase in price created a corresponding financing problem.

More debt might be required.

More equity might be required.

Assets might have to be sold.

The future company would have to generate enough cash to support the resulting capital structure.

The transaction demonstrated something fundamental about leveraged acquisitions:

purchase price and financing cannot be separated.

A bidder does not merely decide that a company is worth a particular amount.

The bidder must also answer:

Can we actually finance that amount, and what will the company look like afterwards?

KKR ultimately prevailed.

The transaction was valued at roughly $25 billion and was by an extraordinary margin the largest leveraged buyout of its time. Contemporary Federal Reserve materials referred to the financing of the "$25 billion RJR-Nabisco buyout", illustrating the unprecedented scale of the transaction in credit markets.

Private equity had demonstrated that it could acquire one of America's largest corporations.

But that achievement came with consequences.

23. Barbarians at the Gate

The RJR Nabisco transaction might have remained principally a landmark in corporate finance had it not been chronicled by journalists Bryan Burrough and John Helyar.

The book did something unusual.

It made a highly complicated leveraged acquisition comprehensible—and entertaining—to readers far outside finance.

Its characters were bankers, executives, lawyers and buyout investors.

Its subjects included valuation, incentives, debt financing, corporate politics, negotiation and ego.

But it read like a drama.

The title was devastatingly effective.

The private equity investor was cast, at least metaphorically, as the barbarian outside the corporate gate.

The image endured.

For many people, Barbarians at the Gate became the cultural origin story of private equity even though the industry had existed in various forms for decades before RJR Nabisco.

That matters because industries are shaped not only by their economics but also by the stories society tells about them.

Private equity would spend decades arguing against the proposition that its business consisted principally of acquiring companies, loading them with debt, cutting costs and extracting value.

KKR itself acknowledges that the “barbarian” label became attached to the firm and influenced perceptions of the industry.

The debate has never entirely disappeared.

24. What happened after the gates were breached?

Winning RJR Nabisco did not make the economic challenges disappear.

Quite the opposite.

The enormous purchase price and associated leverage meant that the company had to generate substantial cash and reduce debt.

Assets were sold.

The capital structure was modified.

The company eventually returned partly to the public markets.

Federal Reserve records from 1991 show RJR Nabisco raising both common equity and high-yield debt, with proceeds being used to repay part of the debt associated with the original leveraged buyout.

The investment did not become the spectacular financial triumph that the drama of winning the auction might have suggested.

That itself is an important historical lesson.

In private equity, winning the deal and winning the investment are not the same thing.

An acquisition is merely the beginning of an investment.

The return is determined by what happens afterwards.

That idea would become increasingly important as the industry matured.

25. The end of the 1980s boom

By the end of the decade, the conditions that had fuelled the buyout boom began to deteriorate.

Some companies had taken on excessive amounts of debt.

Some acquisitions had been completed at prices that left little room for error.

Economic conditions weakened.

Credit became less readily available.

The high-yield market came under pressure.

Drexel Burnham Lambert collapsed into bankruptcy in 1990 following legal and financial problems associated with the securities scandals of the era.

The leveraged-buyout machine slowed dramatically.

Federal Reserve records from the period show both the stress in high-yield markets and attempts by leveraged companies to reduce debt through asset sales, equity issuance and refinancing.

The first great LBO boom was over.

But private equity was not.

This distinction is important.

A financing cycle had ended.

An asset class had not.

26. The 1990s: private equity grows up

The private equity industry that emerged during the 1990s was different from the one that had entered the RJR Nabisco auction.

The fundamental buyout model survived.

But the industry became more institutional.

Fundraising became increasingly systematic.

Managers developed longer track records.

Investor relations became a professional function.

Fund documentation became more detailed.

Investment committees became more formal.

Due diligence became more extensive.

Portfolio monitoring became more sophisticated.

Managers developed industry specialisations.

Institutional investors became more experienced at selecting and monitoring private equity funds.

An ecosystem of professional advisers expanded around the industry.

Private equity increasingly required specialist:

lawyers;
accountants;
tax advisers;
fund administrators;
placement agents;
lenders;
consultants;
valuation specialists;
and eventually technology and data providers.

This was no longer simply a small group of entrepreneurial dealmakers.

Private equity firms themselves were becoming institutions.

27. The emergence of operational value creation

The industry's language also began to change.

The 1980s image of private equity emphasised financial engineering.

Debt.

Acquisition price.

Asset sales.

Capital structure.

Those things remained important.

But managers increasingly emphasised what happened inside the portfolio company.

Revenue growth.

Margins.

Strategy.

Management.

Procurement.

Pricing.

International expansion.

Acquisitions.

Technology.

Working capital.

Organisational design.

The phrase operational value creation became increasingly important.

This did not mean financial engineering disappeared.

Nor did it mean every private equity owner suddenly became an operational expert.

Rather, it reflected the maturation of the investment model.

As more capital entered the asset class and competition for attractive companies increased, simply finding an obviously undervalued business and applying leverage became harder.

Managers needed additional ways to generate returns.

Private equity was gradually developing from a financing technique into a more comprehensive model of active ownership.

28. Venture capital experiences its own transformation

While buyout firms institutionalised, venture capital was undergoing another extraordinary period of development.

The personal computer industry expanded.

Software became an enormous business.

Semiconductors continued to advance.

Biotechnology created an entirely new investment frontier.

And eventually the internet transformed expectations about what young technology companies could become.

Venture firms backed companies that would reshape entire industries.

The spectacular successes attracted more capital.

Entrepreneurs increasingly understood venture financing.

Employee stock options spread ownership among management and technical staff.

Silicon Valley developed an extraordinarily dense network connecting founders, engineers, investors, lawyers, recruiters and potential employees.

Private equity had therefore developed at least two powerful branches.

One financed companies at the beginning of their lives.

The other acquired established businesses and attempted to improve them.

Their risk profiles were different.

Their use of debt was different.

Their ownership structures were different.

But their economic architecture remained related:

outside capital entrusted to specialist managers to invest in illiquid private businesses in anticipation of future value creation and eventual realisation.

29. The dot-com boom and bust

The late 1990s produced an extraordinary technology boom.

Internet businesses attracted enormous amounts of venture capital.

Companies could achieve extraordinary valuations despite limited operating histories and, in some cases, little revenue.

Initial public offerings provided lucrative exits.

Success attracted still more capital.

The cycle accelerated.

Then the technology bubble burst.

From 2000 onward, many internet companies failed or lost most of their value.

Venture portfolios suffered severe losses.

Fundraising declined.

Once again, private markets demonstrated a recurring characteristic:

Capital often arrives most enthusiastically after a strategy has already produced exceptional returns.

Competition then increases.

Prices rise.

Standards can weaken.

And future returns become harder to achieve.

The dot-com collapse did not destroy venture capital any more than the end of the 1980s LBO boom had destroyed buyouts.

Instead, the industry went through another cycle of contraction, adaptation and eventual renewal.

30. Private equity becomes global

By the beginning of the twenty-first century, private equity was no longer principally an American phenomenon.

European private equity had developed significantly.

London became a major centre for European buyouts.

Firms such as CVC, Permira, Apax, EQT and others developed substantial international businesses.

US managers expanded into Europe and Asia.

Asian private equity markets developed.

Cross-border transactions became routine.

Institutional investors increasingly constructed global private-equity portfolios rather than treating the asset class as a purely domestic allocation.

The industry also diversified.

A firm initially known for buyouts might expand into:

growth equity;
private credit;
infrastructure;
real estate;
distressed investing;
secondaries;
energy;
and other private-market strategies.

The vocabulary began to change accordingly.

Increasingly, people spoke not merely about private equity, but about private markets or alternative assets.

31. The rise of the secondary market

The growth of private equity created another problem.

Limited partnership interests were illiquid.

An investor committing to a ten-year private equity fund could not simply redeem the investment from the manager.

But circumstances change.

A pension fund may alter its asset allocation.

A bank may face regulatory pressure.

An investor may need liquidity.

A portfolio may contain too many relationships.

A merger between institutions may create overlapping fund positions.

This produced a market for secondaries.

Specialist investors began purchasing existing interests in private equity funds from original LPs.

Over time, the secondary market became increasingly sophisticated.

Transactions expanded from individual fund interests to portfolios worth billions.

Later, GP-led transactions would develop in which managers themselves arranged liquidity solutions around existing portfolio companies.

The emergence of secondaries is historically important because it demonstrates how financial ecosystems develop around illiquid assets.

Private equity remained illiquid relative to public equities.

But a market emerged to trade the illiquidity itself.

32. The pre-crisis mega-buyout era

By the middle of the 2000s, conditions for leveraged buyouts had become extraordinarily favourable.

Interest rates were relatively low.

Credit was abundant.

Institutional investors were searching for yield.

Leveraged-loan and high-yield markets were highly receptive.

Private equity funds had raised enormous amounts of capital.

Lenders competed aggressively to finance transactions.

The Bank for International Settlements observed in 2005 that leveraged-buyout activity had reached its highest level since the 1980s, while buyout fundraising and the availability of financing had risen sharply.

The scale of transactions increased again.

The record established by RJR Nabisco no longer appeared untouchable.

Large public companies could once again be taken private.

Club deals—in which several private equity sponsors joined together—allowed enormous equity cheques to be assembled.

Transactions such as HCA, TXU and others came to symbolise a new era of mega-buyouts.

Private equity had returned to the scale of Barbarians at the Gate, but this time the industry surrounding it was far larger and more institutional.

Then the credit markets stopped.

33. The Global Financial Crisis

The financial crisis of 2007–2009 represented the most serious test of the modern private equity industry since the collapse of the 1980s LBO boom.

The immediate problem was financing.

Leveraged buyouts depend upon functioning credit markets.

When lenders lose confidence, the amount of debt available for acquisitions can collapse rapidly.

The Bank for International Settlements recorded that debt issuance associated with leveraged buyouts had risen dramatically before the crisis, peaked in early 2007 and subsequently collapsed as tighter credit conditions, debt overhang and declining earnings expectations brought the LBO market almost to a halt.

Deals that had been agreed before the crisis suddenly became difficult to finance.

Banks found themselves committed to financing transactions that the market no longer wanted to absorb.

New buyout activity collapsed.

Portfolio companies faced recession.

Earnings fell.

Highly leveraged capital structures came under pressure.

Exit markets became extremely difficult.

IPOs largely closed.

Strategic buyers became cautious.

Credit tightened.

For private equity managers, this exposed the practical meaning of illiquidity.

A public-market investor facing deteriorating conditions can sell.

A private equity fund may have no such option.

The company is still owned on Monday morning.

Employees still need to be paid.

Customers still need to be served.

Debt covenants still matter.

Management decisions still need to be made.

Private equity managers therefore had to work through the crisis inside their portfolio companies.

34. What the financial crisis changed

The crisis did not destroy private equity.

Indeed, many portfolio companies survived better than had initially been feared.

But the experience accelerated several changes already underway.

Portfolio operations became increasingly professional.

Managers paid greater attention to downside scenarios.

Capital structures were scrutinised more carefully.

Liquidity within portfolio companies became a central concern.

Operational improvement received still greater emphasis.

Private equity firms increasingly employed executives whose principal role was not to find and execute transactions but to work with companies after acquisition.

The industry also learned another important lesson.

A private equity fund's long life can be a disadvantage when capital is trapped in a poor investment.

But during a financial crisis it can also be a source of resilience.

The fund itself generally does not face the same daily redemption pressure as an open-ended investment fund.

LPs cannot ordinarily demand their committed capital back merely because markets have fallen.

The manager may therefore have time to work through the problem.

The illiquidity that creates one form of risk can simultaneously provide a degree of structural patience.

35. The post-crisis world: low rates and abundant capital

The economic environment following the Global Financial Crisis proved remarkably supportive of private markets.

Central banks reduced interest rates dramatically.

For long periods, government bond yields were extraordinarily low.

Institutional investors still needed to generate returns sufficient to meet long-term liabilities.

The search for yield intensified.

Private assets became increasingly attractive.

Pension funds, sovereign wealth funds, insurers, endowments and other institutional investors increased allocations to alternative investments.

At the same time, debt became inexpensive.

Buyout financing returned.

Private equity funds became larger.

Successful managers raised successor funds at increasingly rapid intervals.

The largest firms developed multiple strategies.

A manager might have separate funds for:

large buyouts;
middle-market buyouts;
Asia;
infrastructure;
real estate;
growth;
credit;
secondaries;
and other specialist strategies.

Private equity firms were becoming diversified financial institutions.

36. The rise of the mega-manager

This development transformed the nature of the private equity firm itself.

The traditional image was a partnership of dealmakers managing one buyout fund.

The modern alternative-asset manager could look very different.

It might employ thousands of people.

Operate on several continents.

Manage hundreds of billions of dollars.

Have dedicated capital-markets teams.

Employ large groups of operating professionals.

Manage insurance assets.

Provide private loans.

Own infrastructure.

Invest in property.

Operate sophisticated data platforms.

And itself be publicly listed.

The private equity manager had, paradoxically, become a major public financial institution.

Blackstone listed shares in 2007.

KKR followed.

Apollo and other alternative managers also accessed public markets.

This created an interesting historical reversal.

Firms specialising in taking companies out of public markets had themselves become public companies.

37. Private credit and the expansion of private markets

Another important development occurred in lending.

Following the financial crisis, regulatory changes and balance-sheet constraints affected the ability and willingness of banks to provide certain forms of corporate credit.

Private investment managers moved into the space.

Private credit grew rapidly.

Funds could lend directly to companies without the loan necessarily being originated and retained by a traditional bank.

For private equity sponsors, this created additional financing options.

For institutional investors, it created another private-market asset class.

The distinction between “private equity firm” and “alternative asset manager” became increasingly blurred.

The industry was no longer concerned only with who owned the equity in private companies.

It increasingly intermediated private capital across much of the corporate balance sheet.

38. Companies stay private for longer

Another structural change reinforced the growth of private markets.

Successful companies increasingly remained private for longer.

Historically, a growing company might need to access public markets relatively early in its development to obtain sufficient capital.

By the 2010s, enormous pools of private capital were available.

Late-stage venture funds.

Growth-equity funds.

Sovereign wealth funds.

Private equity funds.

Private credit.

Large institutional co-investors.

A company could raise billions while remaining privately owned.

The boundary between venture capital and public equity therefore moved.

Private markets could finance companies at stages of development that previously might have required an IPO.

The universe of investable private assets expanded.

39. The growth of co-investment

Institutional investors also became more sophisticated.

An LP no longer necessarily wanted exposure to private equity only through a blind-pool fund.

Large investors developed internal private-market teams.

They negotiated co-investment rights, allowing them to invest directly alongside managers in particular transactions.

Some established separate accounts.

Others invested directly in companies.

Sovereign wealth funds and major pension institutions became significant participants in transactions in their own right.

The relationship between GP and LP was therefore evolving.

The GP remained the specialist manager.

But the largest LPs increasingly possessed substantial expertise of their own.

This affected fees, governance, access to transactions and the balance of bargaining power in fundraising.

40. The growth of the secondary market and continuation funds

The secondary market also developed far beyond its original purpose of helping LPs sell unwanted fund interests.

Managers increasingly faced another problem.

A fund might own an attractive company near the end of the fund's expected life.

The manager might believe substantial additional value could still be created.

Some existing LPs might want liquidity.

Others might prefer to remain invested.

Selling the company to an unrelated buyer was no longer the only solution.

A continuation vehicle could acquire the asset from the existing fund.

Existing investors could choose, subject to the structure of the transaction, between receiving liquidity and continuing their exposure.

New secondary investors could provide capital.

This development illustrates how far the private equity market had evolved.

An asset class once characterised by a relatively simple sequence—

raise fund → buy companies → sell companies → liquidate fund

had developed an increasingly sophisticated liquidity and capital-management infrastructure.

That sophistication would create new opportunities—and new questions about conflicts, valuation and carried interest.

41. COVID-19: an unexpected stress test

In early 2020, the COVID-19 pandemic produced an economic shock unlike the Global Financial Crisis.

Entire industries temporarily stopped operating.

Travel collapsed.

Hotels closed.

Restaurants closed.

Retail stores closed.

Supply chains were disrupted.

At the same time, technology adoption accelerated dramatically.

The effect on private equity portfolios therefore varied enormously by sector.

Some companies faced existential liquidity problems.

Others experienced extraordinary growth.

Private equity managers again discovered the significance of active ownership.

Cash positions had to be assessed.

Debt facilities were reviewed.

Management teams needed support.

Costs were reconsidered.

Additional capital was sometimes required.

Acquisition opportunities also emerged.

Financial markets recovered with remarkable speed following extraordinary monetary and fiscal intervention.

Private equity activity subsequently accelerated dramatically.

42. The 2020–2021 boom

By 2021, private markets were operating in an extraordinary environment.

Interest rates remained exceptionally low.

Debt was readily available.

Public equity valuations were high.

Institutional capital continued flowing into alternatives.

Fundraising was strong.

Competition for assets was intense.

Valuation multiples increased.

Deal activity surged.

Private equity firms raised ever-larger funds.

Technology became an increasingly important component of buyout portfolios.

The boundaries between venture capital, growth equity and traditional buyouts became less rigid.

For a period, it appeared that the long expansion of private markets might simply continue.

Then inflation returned.

43. The end of cheap money

The inflationary surge following the pandemic led central banks to raise interest rates sharply.

For private equity, this represented a fundamental change.

For more than a decade, much of the industry had operated in an environment of relatively cheap debt and generally rising valuation multiples.

Higher interest rates changed several elements of the model simultaneously.

Debt became more expensive.

The amount of leverage lenders were willing to provide could decline.

Interest expense consumed more cash flow.

Valuation multiples came under pressure.

Potential buyers became more cautious.

IPO markets weakened.

The gap between what sellers wanted and what purchasers were willing to pay widened.

Exit activity slowed.

And when exits slow, cash distributions to LPs slow as well.

This matters because private equity is ultimately a cash-flow system.

LPs commit capital.

GPs call it.

Investments are made.

Investments are realised.

Capital and profits are distributed.

Those distributions help LPs finance new commitments.

When realisations slow, the entire cycle becomes less fluid.

The industry's old characteristic—illiquidity—had reasserted itself.

44. The denominator effect and institutional portfolios

The market correction also demonstrated another peculiarity of private equity allocations.

Public-market prices adjust continuously.

Private-company valuations adjust periodically and often more slowly.

Suppose an institutional investor has:

€80 of public assets; and
€20 of private assets.

Private equity therefore represents 20% of the portfolio.

If public markets fall rapidly to €60 while the reported value of private assets initially remains €20, private equity suddenly represents 25% of the portfolio.

Nothing needed to be purchased.

The allocation increased because the denominator fell.

This denominator effect can leave institutional investors apparently overallocated to private equity precisely when market conditions might otherwise make new investments attractive.

The phenomenon is not new, but periods of sharp public-market adjustment make it particularly visible.

It illustrates again that private equity cannot be considered independently of the portfolios of the investors who supply its capital.

45. The modern liquidity problem

By the mid-2020s, another issue had become increasingly important.

Private equity managers owned substantial portfolios of companies acquired during the preceding boom.

Many LPs wanted distributions.

But exit conditions were less favourable than during the era of exceptionally cheap money.

Managers faced a choice.

Sell at prices they considered unattractive.

Hold investments longer.

Use continuation vehicles.

Recapitalise companies.

Seek alternative liquidity.

Or wait for markets to improve.

The emphasis among institutional investors consequently shifted toward DPI—Distributions to Paid-In Capital.

An attractive unrealised valuation was no longer enough.

Investors increasingly wanted cash back.

McKinsey's 2025 private-markets survey found that LP attention to DPI had increased markedly, reflecting the growing importance of actual distributions after a prolonged period of slower exits.

This is historically significant.

It represents a return to one of the most fundamental truths about private investment:

An investment is ultimately realised in cash, not in a valuation model.

46. Private equity today

Private equity today bears little superficial resemblance to the industry of Georges Doriot or the early KKR partnership.

The largest private-market managers have become global financial institutions.

They manage capital across:

buyouts;
venture capital;
growth equity;
private credit;
infrastructure;
real estate;
secondaries;
insurance;
and numerous specialist strategies.

Their investors include:

pension funds;
sovereign wealth funds;
insurance companies;
endowments;
foundations;
family offices;
banks;
high-net-worth individuals;
and, increasingly, broader private-wealth channels.

The scale is enormous.

Yet scale has not eliminated cyclicality.

The industry experienced a difficult adjustment after the end of the ultra-low-rate period, followed by renewed activity. McKinsey reported that global private-equity deal value rose 19% in 2025 to approximately $2.6 trillion, while buyout activity accounted for much of that increase.

The industry continues to evolve.

Private credit has become increasingly important.

Secondary markets are expanding.

Continuation vehicles are becoming part of mainstream portfolio management.

Private wealth is becoming a larger source of capital.

Technology and data are becoming increasingly important to sourcing, underwriting and portfolio management.

And the largest managers increasingly compete across almost every part of private capital.

47. An industry transformed—but an economic model that remains recognisable

It is tempting to look at today's enormous alternative-asset managers and conclude that little connects them with ARD's $70,000 investment in Digital Equipment Corporation.

But beneath the scale and complexity, the fundamental economic relationship remains surprisingly recognisable.

In 1957, ARD had to decide whether Kenneth Olsen and Harlan Anderson could turn an idea into a valuable company.

ARD had to commit capital before the outcome was known.

The investment was not readily liquid.

The investor participated in governance.

Success required time.

And the ultimate return depended upon the value created by the underlying company.

Two decades later, KKR had to persuade investors to entrust capital to a specialist manager capable of identifying and acquiring established businesses.

The investments were illiquid.

They required active ownership.

Their outcomes depended upon decisions made over many years.

The manager participated in successful investment profits.

By 1988, the same basic model had accumulated enough capital and financing capability to acquire RJR Nabisco for approximately $25 billion.

By the twenty-first century, it had become a global asset class involving trillions of dollars.

The scale changed.

The institutions changed.

The financing markets changed.

The technology changed.

The contractual arrangements became vastly more sophisticated.

But the underlying relationship remained:

investors provide capital;specialist managers deploy it;the capital is committed for extended periods;the investments are relatively illiquid;the manager exercises substantial discretion;value must be created or captured during ownership;investments must ultimately be realised;and the resulting profits must be divided between the providers and managers of capital.

It is that final relationship that brings us to the central subject of this Bible.

The history of private equity is therefore not merely background to the history of carried interest.

The two developed together.

As private investment evolved from wealthy families financing individual ventures into an institutional industry managing enormous pools of third-party capital, a mechanism was required to align the people who owned the capital with the people who decided how to invest it.

Carried interest became one of the principal answers.

To understand why it took the forms it did, however, we first need to understand in greater detail how the private equity model itself works: how funds are formed, how capital is committed and drawn, how investments are acquired and financed, how value is created, how investments are realised, and how the resulting cash flows move between the parties.

That is where we turn next.

Need assistance with your Carried Interest Challenges? Reach out to us:

[email protected]

Part I - Origins and history