Masters of Private Equity: Warren Hellman, Tully Friedman and Joseph Rice

How two private equity firms turned losses into process

Private equity's first generation built the industry by treating a purchase as the start of a relationship that needs nurturing, discipline, sharing and accountability. Robert Finkel's book, walked through in this episode, shows how two firms made that idea pay. Clayton, Dubilier & Rice hired operating partners who could run the companies it bought, while Hellman & Friedman chased asset-light franchises and treated every deal as guilty until proven innocent. Both were shaped as much by their losses as by their wins.

Takeaways

• Operating partners are Clayton, Dubilier & Rice's edge. Rice built the firm around financial skill plus operating capability. Operating partners have served as interim chief executive in about a third of its investments, and the firm reviews roughly 100 offering books for every deal it does. He says they bring pattern recognition from living through cycles.
• Hellman & Friedman buys asset-light franchises. The firm favors companies with fewer physical assets, lower capital costs, lasting franchises and management with aligned incentives. Every potential investment is considered guilty until proven innocent and has to earn its place in the portfolio.
• Lexmark repaid debt and returned four times. The 1991 carve-out from IBM cut product development from about 30 months toward 15, gave employees ownership worth more than $1bn at IPO, repaid $300m of debt that year and returned over four times the original investment by 1995.
• Mobile Media shows the risk of conviction. The paging company had been worth three times the investment before the industry collapsed. Matt Berger refused another $5m, saying he would not put in 25 cents more. Fred Wilson argues the biggest risk is not investing at all.
• People decide whether a deal works. Hellman says it is impossible to overstate the people quadrant. Rice says he is not a great financial analyst and relies on partners who complement his weaknesses. Partners Group's sweat equity made some chief executives $100m or more.
• Doriot framed companies as living things. Finkel's father impersonated Georges Doriot, the founding father of private equity, at the dinner table. Doriot held that studying a company means studying living relationships that fall apart unless they are constantly pushed ahead and improved.

The Levi Strauss buyout

• Hellman & Friedman and the Haas family bought Levi Strauss for about $1.6bn, with roughly $1.2bn borrowed.
• The family rolled about $400m of its stock into the deal and kept about 93% of the company. H&F held about 7%.
• Levi proved cyclical and Bob Haas had to reinvent it every few years.