When buyout groups Hellman & Friedman and Permira began stalking a takeover of business software giant Zendesk in February, they tried to bring in a third partner for what would be a large deal. They called Blackstone, a firm that manages more than $125bn in private equity assets and that they each knew well from previous transactions.

Blackstone was initially interested in Zendesk but in the end it passed on the investment. However, the firm’s involvement did not end there. When H&F and Permira eventually announced their $10.2bn acquisition of the software company in June, the press release did not name any of the Wall Street banks that would usually provide the bridge loans to complete such a deal.

Instead, H&F and Permira said that amid choppy capital markets they had secured more than $4bn of debt financing. The debt came from a group of would-be competitors led by Blackstone.

Firms like Blackstone and Apollo, another lender in the deal, made their names as swashbuckling takeover artists. The industry was founded from the 1970s to the early 90s by small teams of mercenary dealmakers, who then duelled with each other to win control of large corporations such as RJR Nabisco, Alliance Boots, and Phillips Semiconductor.

Private equity firms have since grown to manage almost $10tn in assets and have become the dominant force in global financial markets.

But as the industry has expanded, its character has been transformed. Firms that once bludgeoned opponents now nurture complex business relationships with their competitors. Private equity has become just a fraction of their overall assets under management, with credit investing businesses now managing hundreds of billions of dollars, including providing loans for leveraged buyouts.

The result of these sprawling empires is that once heated rivals increasingly see the benefits of a level of co-operation between different business units that once seemed inconceivable.

“Private equity started 35 years ago as a dark art. Now it is an asset class,” Marc Rowan, chief executive of Apollo Global, told an audience earlier this year. “There are no permanent friends or permanent enemies anymore.”

With private equity deals now accounting for over 25 per cent of global M&A activity — a record market share — the collective power of the leading groups is starting to attract the attention of regulators.

Private equity takeovers, once rubber stamped by antitrust authorities, are now being treated with the scrutiny reserved for large corporations, competition watchdogs have told the Financial Times.

It is a striking reversal for a sector that has more often in the past been criticised by politicians for its ruthlessness rather than its clubbiness.

“When you have repeated relationships, you are just not going to go to war with the same ferocity,” says Josh Lerner, a professor at Harvard Business School, who has studied private equity for decades.

Relationships that run deep

The Zendesk takeover is illustrative of how deep the ties can run between leading private equity firms.

The origins of the takeover go back to 2016 when Permira invited H&F to make a minority investment in a call centre technology company called Genesys, which it had bought from Alcatel-Lucent four years earlier. H&F invested $900mn in Genesys at a $3.8bn valuation, more than double Permira’s initial investment.

H&F and Permira initially studied merging Genesys with Zendesk, according to sources directly involved in the deal. When the idea did not advance, they turned to Blackstone, which helped arrange more than $4bn in debt financing that is now the largest private financing on record.

For Blackstone, it meant supporting a deal led by two of its most important customers. Blackstone Credit, the buyout firm’s $230bn in assets lending arm, is a reliable lender to both firms. It provided the majority of $1.2bn in financing for H&F’s takeover of NPD Group in October 2021 and $2.2bn in debt for Permira’s take-private of cyber security group Mimecast two months later.

H&F co-led the largest leveraged buyout of 2021 alongside Blackstone, taking control of medical supplier Medline Industries for $34bn. A year earlier, the two firms struck an equally ambitious deal to merge their combined investments in human resources IT company Ultimate Software and cloud software specialist Kronos, in a $22bn deal.

To buy Zendesk, H&F and Permira raised billions in debt against a business that generated just $80mn in profits last year, far more than what regulated banks could offer, according to three people involved in the deal.

Blackstone, which considers H&F a skilled partner for takeovers, took part in the financing, as did Apollo, which financed more than $750mn of the takeover, and counts both firms among the 25 private equity firms to which it has lent over $40bn. Famed for its ruthless tactics with debtholders, Apollo now aspires to become a go-to financier for the deals organised by competitors.

“The zero-sum game mentality of old school dealmakers that always assumed that for them to win someone had to lose is really an outdated point of view,” says an executive at one of the industry’s largest global firms. “There are so many opportunities. Today you are competing and tomorrow you will bring them in as a partner on a deal. It is the new reality.”

Aggressive outsiders

The modern day private equity buyout traces to Michael Milken’s Drexel Burnham Lambert, the investment bank that popularised the “junk bond”. Drexel financed small teams of dealmakers targeting corporate giants such as Disney, Texaco and then RJR Nabisco, the signature LBO of the go-go 1980s.

Milken, and many of Drexel’s clients, were considered aggressive outsiders, unafraid to gatecrash Wall Street.

“The Drexel guys that Milken was backing were pretty non-genteel types,” says a buyout executive who worked in that era. “It was like the Gold Rush. The guys who couldn’t make it in the city went off to look for gold.”

By the 2008 crisis, private equity had become part of the financial mainstream as it pulled off a string of ever-larger takeovers. These so-called “club deals” hinted at the willingness of some firms to co-operate out of self-interest.

Buyout firms, then privately owned partnerships almost exclusively focused on corporate takeovers, could not always afford to purchase on their own some of the companies they considered attractive targets — such as hotelier Hilton, utility TXU, retailer Toys “R” Us, and hospital chain HCA. However, by assembling consortiums of competitors that each contributed a slice of the equity, almost any deal became possible.

These club deals led to some legal battles. A 2007 civil lawsuit in Massachusetts led by a pension fund in Detroit accused 16 private equity firms of forming consortiums that rigged bids in sale processes.

The case centred on the $33bn LBO of HCA, which was won by Bain Capital, KKR and Merrill Lynch, after there were no other competing bids. Emails unearthed by lawyers showed competitors refraining from outbidding each other.

“I don’t want to be in a pissing battle with KKR at the same time we are teaming on other deals,” said David Rubenstein, one of Carlyle’s founders, in an email unearthed during the litigation.

These deals were not all successes. Toys “R” Us, for instance, fell into restructuring. Moreover, to settle the Massachusetts litigation, Goldman Sachs and Bain Capital paid $121mn, while KKR, Blackstone and TPG agreed to pay $325mn, all without admitting or denying guilt.

By the time of the financial crisis, club deals had mostly vanished as investors found themselves exposed to the same failing investments in multiple funds and called for an end to the practice.

But the crisis also opened a window for buyout firms to transform themselves into much broader operations that are shifting the balance of power in finance towards private markets.

Investment banks, hamstrung by new regulations like the 2010 Dodd Frank Act, were curtailed from holding risky assets such as low-rated debts, which has limited their ability to finance many deals. As a result, corporations and private equity buyers have had to seek new ways of issuing debt. Blackstone, Apollo, KKR and Carlyle stepped into the void.

They bought billions of non-performing loans from banks in the US and Europe, betting that the portfolios would stabilise. As markets recovered, they shifted to originating new loans, underwriting midsized private equity takeovers that banks would not finance.

It set off private equity’s march into new businesses such as lending, insurance-related investments, real estate and infrastructure, which were far from their original speciality in buyouts.

Blackstone acquired debt manager GSO in 2008, seeding its expansion into credit and insurance-based investments, which now comprise 28 per cent of the group’s $940bn in assets.

Apollo, under current chief executive Rowan, built an insurer called Athene that was designed to invest fixed-rate annuity premiums into complex debts, like senior loans. These credit investments are now Apollo’s biggest and fastest growing business.

In private lending markets, the fastest growth has come from financing software takeovers, like Zendesk, which banks cannot handle due to the level of leverage involved. Several other large software deals this year, like Thoma Bravo’s $10.4bn takeover of Anaplan, were financed by private lenders because the leverage ratios on the debt are beyond what banks are comfortable handling.

In these deals, lenders will “club up” by assembling a consortium of competitors, resembling the consortiums of the pre-crisis era.

These private financings have continued as interest rates rise — just as many investment banks have been refusing to make new lending commitments until loans from deals struck earlier in the year have been sold on. The result has been a halt in the market for bank-financed takeovers and the private lenders winning market share.

“The idea that we would work with KKR and Blackstone to provide debt for us once seemed like a crazy idea. Today, people don’t even think about it,” says the head of one private equity firm. “There are no clean lines. Everyone is a competitor, a collaborator and a partner.”

This web of relationships has changed the character of the industry. “It is costlier than ever to be a jerk,” says Steven Kaplan, an expert on private equity who teaches at the University of Chicago. “If they behave badly in one deal, they will be treated differently in the next deal.”

The ties stretch far beyond lending. The fastest way for buyout firms to deploy their nearly $2tn in “dry powder,” or funds they have raised that have yet to be invested, is to buy companies directly from other private equity firms. A record 442 of such deals worth $62bn were struck last year, according to Refinitiv.

These deals can close in less than three months, say bankers, versus as long as nine months to acquire a public company. They can also be expedient: sellers sometimes look to quickly lock in gains and show strong returns as they raise their next fund, notes one private equity firm executive.

“A lot of times you have good companies that a sponsor owns, but they need to sell to show dollars realised for their fundraising,” says the executive.

There has also been a surge in so-called “GP-led secondary transactions,” where one private equity firm sells a large stake in an existing investment to another firm at a higher valuation.

One of the industry’s earliest major deals was H&F’s 2014 sale of a $750mn minority interest in Kronos, a seller of cloud-based time sheet services, to a group of buyers led by Blackstone, that were willing to take lower governance rights and leave H&F in control of the deal.

Five years later, H&F led a deal to acquire Ultimate Software for $11bn, bringing in Blackstone and GIC, its same partners on the Kronos stake sale. Blackstone’s debt arm co-led $900mn in financing for the riskiest piece of the deal’s $3.4bn total debt package, helping to get it over the line.

The two private equity firms then merged Ultimate Software with Kronos a year later, generating billions of dollars in gains, underscoring how close relationships can get deals done.

Can it last?

The first test of the private equity industry’s new co-operative structure was the coronavirus pandemic. Broad swaths of the global economy closed, threatening to create a wave of defaults for private lenders that had financed a flurry of takeovers.

What occurred instead was a mass forbearance as private equity borrowers and their lenders amended loans to give companies breathing room. To smooth the new and more lenient liquidity measures and show good faith, some borrowers added additional equity to the deals.

“The whole concept was we’re not going to foreclose,” says one borrower involved in numerous negotiations. “They’re in the business of ideally doing multiple deals with your portfolio companies. They know that if they act poorly, my job is to not show them future business.”

One such example was a company called European Wax Centre, an operator of hair removal salons that was acquired in 2018 by private equity firm General Atlantic with a $180mn loan from private lender Blue Owl. When the pandemic shuttered the company’s salons, Blue Owl voluntarily amended the loan to forestall a cash crunch and General Atlantic made an over $10mn cash infusion as a concession.

After the economy reopened, European Wax recovered and its debts were refinanced at par. Last year, the company went public, valuing General Atlantic’s stake at $639mn, several multiples of its original investment.

Young Soo Jang, a PhD student at the University of Chicago, has studied private lenders’ behaviour by examining over 200 deals that fell into distress during Covid.

He found private lenders were twice as likely as the broadly syndicated loan market to ask for borrowers to agree to inject new capital into deals, forestalling restructuring. Five per cent of distressed private deals led to bankruptcies, according to the research, half the rates of bank financed deals.

“A lot of the direct lenders put out a lot of capital . . . They were extremely nervous,” adds one executive involved in these deals. “Everyone benefited from the fact that there was such a sharp snap back in the economy.”

The global economy sidestepped a brewing financial crisis during the pandemic thanks to an unprecedented policy response.

But as financial markets enter another troubled moment amid the war in Ukraine and central bank tightening, the ties between firms will be tested again.

“This increased co-operation and cosiness is really a bull market phenomenon,” says Lerner, the Harvard professor, who expects falling markets will unearth new conflict as deals sour, pitting parties against each other.

However, the firms involved in the Zendesk financing insist these new relationships will not break.

“It is very hard to be a credible direct lender and a hostile investor,” says the head of one firm involved in the deal. Another adds: “We’re just trying to get our money back and get a return.”