Yesterday's New York Times [registration required] discusses the pending initial public offering (IPO) of Kohlberg Kravis Roberts & Co. (KKR). In so doing, it glosses over the role of its founding partner, Jerome Kohlberg. But just because The Times ignores him, that's no reason for you to.
That's because I interviewed him three years ago for the Swarthmore College Bulletin. So without further ado, here's my interview with him:
"Kohlberg was co-founder of the leveraged buyout specialist KKR and is now special limited principal of Kohlberg & Co. His business success began with the simple yet powerful notion that it was better to risk one's own capital than to be an intermediary. "One of my friend's fathers was a merchant banker,' he recalls. "He didn't act for commissions. He stood and fell on his own investments, which he put beside those of other clients. I realized that being a principal was what I wanted.""
This insight drew Kohlberg into investment banking. "I went to The Bear Stearns Companies (NYSE: BSC), where we invented buyouts. They were called bootstraps," he says. In bootstraps, investors purchase control of companies financed largely through bank loans, while giving managers a significant equity stake to link their personal wealth to the companies' financial results. The managers streamline operations and sell the company at a profit within 5 to 7 years.
"I insisted on [Bear Stearns] management having a piece of the equity," says Kohlberg. "I brought up the idea of long-term investments in these bootstraps to the Bear Stearns partners. My proposal was overruled."
This led Kohlberg to start his own company. "After 21 years at Bear Stearns, I left to start KKR. I was like other Swarthmore students who are used to independence." In 1987, Kohlberg went out on his own again, starting Kohlberg & Co. with his son, and retired as a limited partner in 1992."
I'd love to know what he thinks about the KKR IPO -- he has no share of it, according to its prospectus. When I interviewed him, Kohlberg declined to answer the really interesting questions about why he left KKR. But a 1988 Fortune article hints that Kohlberg left in 1987 because he wanted KKR to continue to play a friendly role -- "no more aggressive than white knight to a company in play. Kohlberg yearned to keep things that way, avoiding hostile deals at all costs. Kravis and Roberts, ambitious, driven, and young enough to have long careers ahead, contended that KKR and the deal market had outgrown such niceties. In the end they won."
This difference in philosophy came to a head with KKR's acquisition of Owens-Illinois (O-I), signed in early 1987. According to Fortune, "Here, there were rumors of a raider, but one never emerged. KKR meanwhile came around to talk and found O-I's management ready to do a buyout. In opposition, though, were some of O-I's outside directors, who wanted to see the company remain independent and who fought KKR bitterly. In the end KKR raised its bid by about 10%, made it all cash, and prevailed. Six weeks after this deal was completed, Jerry Kohlberg gave up his role as a general partner of KKR and left."
Not only did Kravis and Roberts win control of KKR, but they also succeeded in keeping the spoils of that victory from government coffers. I find it remarkable how little tax both KKR and Blackstone Group LP (NYSE: BX) pay. In particular, in 2006 KKR's income tax was 0.10% of its $4.2 billion in net income and Blackstone's was 0.14% of its $2.6 billion in net income.
While the partners pay taxes on their capital gains, at 15%, as I've posted, I'd like Congress to stop threatening to raise that to 35% by requiring them to put half their compensation in an escrow account. By putting that compensation at risk, my proposal would entitle them to retain that 15% capital gains rate.
Meanwhile, KKR's forgotten partner, Jerome Kohlberg, remains silent.
Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned in this post.
