The early 90s brought the emergence of venture capital and private equity asset classes out; but this came about through a series of cycles which included both booms and busts. The late 80s and early 90s gave us a savings and loan crisis, a real estate market collapse, and a wide variety of inside trading scandals. The early 90s brought on a recession which caused the high-yield debt market to shut down. But toward the end of the decade, more institutionalized private equity firms began to emerge and brought in the huge Dot-com bubble in ’99 and 2000.
The LBO Bust
As the 1980s drew to a close there were obvious signs of the excesses and abuses of the buyout market. The decade of the 80s had resulted in many of the large buyouts ending in bankruptcy. By the early 90s the Nabisco buyout was beginning to show that it was strained. In 1990, it underwent a recapitalization that included a $1.7 billion contribution of new equity from KKR. It was during this time that companies were beginning to perfect the “poison pill” to protect the business from being taken over.
The Drexel Burnham Lambert Collapse
Drexel Burnham Lambert was largely responsible for the private equity boom in the 80s. The investment bank offered leadership in issuing high-yield debt. Drexel began a struggle against allegations in the mid 80s when their investment banker and managing director plead guilty to 4 felony counts involving inside trading. Drexel fought for 2 years claiming that the company had committed no crime but the SEC sued Drexel in ’88 for stock manipulation, insider trading, defrauding clients and stock parking. They were threatened with indictment under the Racketeer Influenced and Corrupt Organizations Act. One of the CEO’s stated that were the company to be indicted under RICO it could not have survived more than a month. In lieu of being indicted the company made an agreement with the government and they pled no contest to 6 felony counts and they also agreed to pay a $650 million fine. Many of the high yield debt markets began to shut down in 1989; this carried over into the 90s and accelerated. In February of 1990 Drexel officially filed Chapter 11 bankruptcy. This was an influencing factor in the shake up of the 90’s in the venture capital industry. However, the big shake up was instrumental in bringing about some of the much needed improvements which helped lead to the VC boom of the 90s.
The VC Boom
The slump of the late 80s carried over into the first half of the 90s and venture capital returns remained relatively low. This was especially true when compared with the leveraged buyouts. Some of the reasons that VC returns remained low were due to increased competition for popular startups, an abundance of IPO’s, and the fact that most VC fund managers were largely inexperienced. In the first half of the 90s the industry remained rather limited and showed an increase of $3 billion to barley over $4 billion from the early 80s to the mid 90s. But the VC managers in more successful firms made it through the shakeup of the early 90s and they were able to retrench and shifted their focus to improving the operations of portfolio companies instead of simply engaging in new investments. These results became very profitable and ended up generating the VC boom that began in the mid 90s. Professor Andrew Metrick of the Yale School of Management referred to the first 15 years of the venture capital industry (1980 to 1995) as the “pre-boom period.” And the late 90s did prove to be a time when VC firms were booming. This boom would last until the Internet bubble burst in 2000. Large VC firms benefited greatly from surges of interest that came from nascent internet and computer technologies during the latter part of the 90s. IPO’s of technology stock and many other growth companies were abundant and VC firms received huge windfall profits which lasted until the Internet Bubble burst and private equity crashed in early 2000 due to the crash of NASDAQ as well as a slump in technology.