There was a time when private equity work was a second-tier concern, something the traditional Wall Street firms would take a pass on in favor of larger—and at the time more lucrative—M&A work that kept the lights on.

Oh, how things have changed.

What was once considered small-time work that couldn't catch the attention of the major financial institutions (or their lawyers) has since grown into a powerful force with a role in seemingly every aspect of the U.S. economy. And it's gotten there with the help of the legal industry.

When law firms like Kirkland & Ellis, Ropes & Gray, Dechert, Simpson Thacher & Bartlett and Paul Hastings first began exploring the world of leveraged buyouts, it was mainly on smaller deals. As Alfred Rose, the former chair of Ropes & Gray's private equity transactions group, says, "These were people who were outside the inner circle of Wall Street."

The term private equity still wasn't ubiquitous when Mark Thierfelder, chair of Dechert's corporate and securities group, started out as a leveraged finance lawyer. In trying to explain who his clients were and what they wanted, he found that companies didn't like the sound of a "leveraged buyout firm."

"They wanted it called a 'turnaround firm,'" he says.

Call it what you want, it's grown exponentially, and the law firms that got in on the ground floor have, too.

Although private equity action hit a speed bump in 2019—down 4% in disclosed deal count year over year and down 7% in total disclosed deal value, according to PitchBook—it still comprised $678 billion in transactions. And private equity is still on an upward trajectory, even if its growth is now more reflective of its stature as a mature industry than the excitable upstart market it once represented.

Facilitated by the innovative lawyers who designed creative tax vehicles, corporate structures and deal incentives as the industry blossomed, private equity became a cycle of prosperity. As private equity firms make money on deals made possible by a structure their lawyers helped build, those lawyers and their firms have been reaping the rewards in turn.

Humble Beginnings

There weren't many firms involved in private equity when it first came on the scene, Brian Richards, chair of Paul Hastings' global private equity practice, says.

"But it's like any market," he says. "Once someone starts making an outsize return, unless there are significant barriers to entry, others will keep entering the market."

When Richards started handling leveraged buyouts, there were few regulations and no real road map to tell lawyers how to handle these transactions. So the attorneys developed them as they went.

"Jack Levin of Kirkland was the godfather of that stuff," Richards says.

Levin, a partner who is still practicing at Kirkland and was named by this publication as one of the 50 most influential lawyers of the last 50 years, had been a litigator, a tax attorney and corporate lawyer before finding himself, along with Simpson Thacher's Richard Beattie, working on the first-ever "risk equity fund," managed by KKR and funded by Levin's client First National Bank of Chicago.

"Over the years the lawyer has been a significant factor in the development of the infrastructure that has allowed this tide to sweep across the world," Levin says.

He cites the "two and 20" arrangement (2% management fee, 20% of profits from the asset returned to the investing fund) as one of the initial devices that fueled interest and growth in what became the private equity industry.

Marni Lerner, head of Simpson Thacher's private equity M&A practice, says pioneers like Beattie and Robert Friedman, a Simpson Thacher partner for 25 years who later became the chief legal officer at Blackstone Group, a longtime firm client, were strong influences on her and helped shape how deals were done from day one, even when they lacked a blueprint. There were no classes to attend, no professors expounding on private equity theory and no grizzled veterans, outside of a select few like Levin, to advise anyone.

"Initially, a lot of it was tax-driven," Richards says. "Then we got into fund creation and structuring. Now business schools teach it."

The lawyers who focused on private equity in the late 1980s and into the 1990s all arrived from other practice areas—M&A, corporate, tax and finance—that each contributed to the field.

Thierfelder, who has been doing private equity work for 28 years now, says he started off trying to get funds for firms, working through the whole range of the credit cycle. Some law firms, like Kirkland, had a practice going back then, "but they didn't have the brand," he says.

"Lawyers weren't coming out of law school saying they wanted to be private equity attorneys," Thierfelder says.

An Industry Evolves

Still in its infancy in 1988, the emerging private equity sector hit a milestone when KKR bought the recently formed RJR Nabisco for $24.88 billion, a record that stood until 2006. Levin and Lerner both identify the deal as a turning point for the industry. Traditional banks had made their respective plays, as did investment banks such as Shearson Lehman Hutton. But KKR came out on top.

That deal was a harbinger of things to come. According to a Milken Institute report, the number of private equity-owned companies has quadrupled in the past two decades, to about 8,000 in 2018, more than the number of public companies listed on stock exchanges that year. The number of private equity deals closed in 2018 was more than double the total from 2009.

The industry's evolution goes beyond the numbers. Private equity firms are now complex entities, no longer only relying on financial engineering as they did decades ago. They grow and manage portfolio companies, maintain lobbying presences in Washington, D.C., and work together on some of the most challenging deals the market can muster. Public companies remain more valuable, on the whole, but private equity's impact on the structure of the investment world is hard to ignore.

Many of the lawyers who helped private equity get off the ground had already demonstrated creativity in other fields, Newcomb Stillwell, co-managing partner of Ropes & Gray's Boston office, says.

"You were inventing a whole new way of financing," he says, "leveraging the assets you are going to buy to secure the loan to buy them."

Clients tended to be entrepreneurs or wealthy families, neither of which necessarily had the business acumen to create and structure a complicated deal in a relatively unregulated vehicle. That gave attorneys the opportunity to do for those clients what they always say they want to do: solve problems.

"As private equity firms proliferated, you needed to find a competitive advantage," Lerner said.

So that's what attorneys did. They started finding ways to insulate firms from bad investments, ways to speed along the closing process for a buyer, ways to make the taxable elements of a deal more palatable and ways to exit a purchase more quickly.

Lerner, who has worked with KKR for years, says creative structures introduced to the deal process have minimized risk for both buyers and sellers, fueling the industry's growth. For example, she says, prior to 2005, a buyer's reputation was all a potential target could bank on when securing the funding to finalize the purchase.

Lerner's firm Simpson Thacher was intimately involved in the 2005 acquisition of SunGard Technologies by a consortium of private equity firms. Among the changes to dealmaking since that time, the financing barrier has largely been removed and replaced by a fee.

"Instead of a financing condition, you have a reverse termination fee, usually around 5-7% of the enterprise value of the target," Lerner explains. "That fee gets paid if the buyer can't come up with the financing."

That innovation, first implemented in the SunGard deal, changed the game for private equity firms, and by 2006 most deals followed suit. Richards, of Paul Hastings, says the elimination of nearly all barriers to closing deals—what he refers to as "the narrowing of the outs"—is among the legal community's most significant contributions to the growth of private equity.

Another notable change, Richards says, is private equity firms' ability to circumvent responsibility for the portfolio companies they buy if they decide to sell an asset. In 1995, for example, a firm could be on the hook for 50% of the liability of an asset company for a certain period of time. Now, however, that liability has essentially been eliminated, mitigating much of the private equity risk in the process.

Kirk Davenport, a retired Latham & Watkins corporate partner, describes the result of these innovations as a "race to the bottom" for securing financing from banks, allowing private equity firms access to more financing at very favorable rates.

"The major development over that period was the standardization of the financing terms, which led to a commoditization of financing terms," Davenport says. "The private equity shops were able to hold an 'auction' for the financing for a given deal and the banks would bid against each other for the loosest covenants and lowest fees."

Once these policies were widely adopted by the private equity industry, the conditions were right for explosive growth.

"Cheap money and loose covenants helped fuel the early days of the private equity boom," Davenport says.

Reputational Risk

In more than a few instances since the private equity industry burst onto the scene, firms have acquired companies only to saddle them with debt that eventually crushed them. It's best for everyone involved (the private equity firm, investors, the target company and its employees) for a company to become profitable, but private equity firms can still make money via structured payouts and management fees while the companies they are running struggle.

Although it's not the norm, high-profile examples of such a situation, including the bankruptcies of Toys "R" Us, Mattress Firm and Claire's, and the continued gutting of media companies, have painted private equity firms—and, by association, the lawyers that work with them—in a potentially negative light.

"It's a good way to blame somebody else for your problems," Richards says. "Companies get blamed for things. But I believe private equity has a positive effect on society, both economically and socially."

Although streamlining and right-sizing a company can lead to layoffs or restructuring, the desired result of a well-run, efficient company is worth the effort, he says.

"Private equity allows companies to unlock their potential," Richards says. "So they aren't being run by Mom or Pop anymore and can have experts come in and really grow."

Many private equity attorneys share that view, conceding that there are bad actors in every industry. The deals are designed to make money, and the easiest way to do that is to make a target profitable.

The bad reputation, attorneys argue, is largely about fear of change—change in how a company is run, who is running it and how many people need to be there to do so. One attorney says that although "the rap is understandable, it isn't completely truthful."

Levin credits private equity for helping change the world economy. Before private equity, companies were mostly large, publicly traded entities or small Mom-and-Pop shops unable to attract investment for growth. Private equity changed all that.

"Robust private equity has made the world a completely different place," Levin says. "The word 'entrepreneur' was not even used before private equity. Now you have a whole new entrepreneurial economy that has improved the standard of living for the whole world."

Changes Still to Come

Industry observers expect private equity—and demand for the legal work it relies on—to continue expanding in the coming years. The top of the Am Law 100 is peppered with firms that count private equity work as a primary revenue driver, and as the industry has grown, so have the firms that lean hardest into it.

Projections for 2020 show a slight decline in private equity fundraising compared with 2019. Analysts are quick to say, however, that those projections would look strong compared with almost any other year on record. With more and bigger deals getting done each year, Thierfelder believes legal team involvement will only increase.

"Changes across the private equity industry have really necessitated that lawyers think more broadly and deeply about their clients' business," he says.

That is where attorneys can bring real value to a deal, according to Gustavo Schwed, a former fund manager and current professor of management practice at New York University's Stern School of Business.

"In lining up advisers, the lawyer is a very important function," Schwed says. "But I don't consider that a strategic choice. If I want to buy a mobile phone company in Lithuania, the strategic people are the ones who can give specific insight into the market. They can provide real value."

That insight is what Schwed sees as the logical next step in the evolution of private equity practice. Now that the industry is matured, the protocols for transactions streamlined and the conditions to close virtually eliminated, the difference makers will be the attorneys who can bring institutional knowledge to a deal.

"It isn't rocket science," Richards says. "The innovation really isn't in the law, but rather helping clients create solutions for problems that arise during any deal."

Rose, of Ropes & Gray, says the current market is tilted about as far in sellers' favor as the pendulum can swing. That will force attorneys to come up with more and more creative solutions to differentiate their private equity clients from the masses, while at the same time limiting their exposure.

"More competition forces you to come up with innovative ways to get deals done," Lerner, of Simpson Thacher, says. "And that gets rewarded."

Levin says the latest development he has seen is funds holding onto companies for longer periods of time in order to grow them and increase the investment return once they are finally sold. It's just another example of how the private equity industry, and the attorneys that help it run, continue to evolve.

Correction: A previous version of this article said Marni Lerner worked with Blackstone group and participated in Simpson Thacher's handling of the Sungard deal. 

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