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Cover Story May 7, 2009, 5:00PM EST

How Private Equity Could Rev Up the U.S. Economy

Two out of five private equity firms will disappear. The rest will feast off the financial wreckage

By Peter Carbonara and Jessica Silver-Greenberg

Donald B. Marron, founder of the $3 billion private equity firm Lightyear Capital, has been eyeing financial wreckage for more than a year. In early 2008 Marron, the former chairman and chief executive of brokerage PaineWebber, sent teams of analysts to scout out more than 200 struggling U.S. financial firms. So far Marron has made only one deal, buying a stake in Higher One, a company that offers financial services to colleges and universities, last summer. But the 74-year-old art aficionado, whose starkly modern New York office brims with abstract paintings, says dealmaking will soon pick up dramatically. "We expect this trend to continue," he says.

While some attention has been paid to the vultures now circling the troubled banking sector, private equity is beginning to venture out across the economy in search of deals big and small. Glen T. Matsumoto, a partner in Swedish buyout shop EQT Partners, is looking for more ways to spend the $1.5 billion his firm has amassed for infrastructure and energy plays, having picked up Michigan energy company Midland Cogeneration Venture in March. Brian A. Rich of Catalyst Investors, an upstart buyout shop with $300 million in assets, recently plowed $5.6 million into Mindbody, a California software company. He's hoping to invest in more cash-starved technology and media outfits. "We think it's a great time to put capital out," says 48-year-old Rich, who ran Toronto Dominion's (TD) U.S. merchant banking arm before starting Catalyst in 2000.

It's been a rough two years for private equity firms, those freewheeling and much-vilified financiers who buy companies only to sell them later for a profit. The buyout boom that ended in 2007 wasn't pretty; many of the deals made at the height of the frenzy have been disasters. Bankruptcy courts are littered with private equity blunders, including household names Chrysler, Tribune (TXA), and Linens 'n Things. Such high-profile blowups heightened private equity's reputation as a group of fast-buck artists who are better at destroying companies than running them.

But a strange thing has happened. While the experts were proclaiming—and maybe even celebrating—their death, private equity firms were quietly bulking up their war chests and readying themselves for a new wave of deals. By some measures they're stronger than ever: Firms are sitting on a record $1 trillion with which to make new purchases, according to research firm Preqin. "They are showing up at the party with a wheelbarrow full of cash," says Donna Hitscherich, a professor at Columbia Business School.

Slowly and deliberately, firms are mobilizing their forces to exploit huge opportunities being created by the recession. Some big buyout firms, filling the void created by the financial crisis, are acting like traditional investment banks, providing loans to troubled companies and even advising executives on mergers. Some firms are aggressively hiring and firing buyout specialists, turning the cold eye they usually train on companies onto themselves. Other firms are prowling bankruptcy courts in search of cheap assets or are capitalizing on government stimulus spending. "There is every reason to believe that private equity will have tremendous opportunity once we hit bottom," says Colin Blaydon, director of the Center for Private Equity & Entrepreneurship at Dartmouth's Tuck School of Business.

When private equity starts cranking up its dealmaking machine—and it will, eventually—the $1 trillion it has amassed could help revive the economy by pumping crucial capital into the markets. "Private equity will be an integral part of this country's economic recovery," says Gregg Slager, a senior partner at accounting firm Ernst & Young. Noted Stephen A. Schwarzman, founder of Blackstone Group (BX), in the private equity firm's March annual report: "Getting the world economy moving again will take more than government intervention."

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