How Stephen Schwarzman Built The Blackstone Group

Once dubbed the undisputed king of the private equity industry by Forbes magazine, Stephen Schwarzman is one of the wealthiest people in the United States. Schwarzman and his team are responsible for overseeing the allocation of capital for several pension funds, sovereign wealth funds, central banks and other institutional investors. The company he founded, The Blackstone Group, L.P. (BX), is the largest alternative asset manager in the world, with more than $330 billion worth of assets under management.

With a wide range of global business interests in private equity, debt financing, hedge fund management and real estate acquisitions, Schwarzman is one of the most powerful people on Wall Street. He was named one of Time magazine’s most influential people in 2007. A benevolent billionaire, Schwarzman has donated hundreds of millions of dollars to different causes over the years. Here is an overview of how he made his fortune and built the world’s most powerful alternative asset manager.

Born in 1947, Schwarzman grew up in a Jewish household in Abington, Pennsylvania and, as a child, attended public schools. While delivering a guest lecture on the global economy to  a class at his alma mater Yale University in 2008, Schwarzman admitted that he was not that good at math. He explained, ‘‘I stopped [studying math] in the eleventh grade. Calculus, for me, was way out of reach. I am more in the add, subtract, divide and multiply category, which worked and still does for me.’’

With no interest in corporate finance, Schwarzman took social science-related courses like psychology and sociology during his time at Yale. While in school, Schwarzman and Former United States President George W. Bush were members of Yale’s infamous secret society Skulls and Bones.

After graduating from Yale in 1969, Schwarzman managed to get a job with an institutional asset management firm called Donaldson, Lufkin & Jenrette (DLJ). At the time, the company had just been listed on the New York Stock Exchange. Now defunct, it was co-founded by Bill Donaldson who also founded the Yale School of Management.

Schwarzman developed a love for the world of corporate finance at the firm. There he learned about the stock market, the money management business and how to analyze financial statements. On one occasion at DLJ, Schwarzman was tasked to interview an executive of a publicly-traded company in order to determine if its stock would make a good investment. However, many of the questions he asked were not answered. Schwarzman later found out that the executive was not trying to be difficult but rather did not want to disclose certain details about the company due to insider trading laws.

Although he understood why the executive could not answer his questions, Schwarzman was uncomfortable with analyzing a potential investment without having all important and relevant important about it at hand. This frustrated him, so decided to further his studies at the Harvard Business School, with the hope of finding a way to resolve this issue.

With a Harvard MBA under his belt in 1972, Schwarzman took on a job at the former investment giant, Lehman Brothers. By the age of 31, he had become the Managing Director of Global Mergers and Acquisitions for Lehman. Following American Express Company’s (AXP) acquisition of Lehman Brothers in 1984, Schwarzman left the firm. He approached Pete Peterson, his former boss who had left Lehman earlier that year, with the idea of starting an investment company.

One year later, in 1985, Schwarzman and Peterson formed The Blackstone Group with $400,000 of their own money. Never a fan of being a stock market speculator, Schwarzman wanted to make private equity investing the heart of Blackstone's business model. He knew that privately-held businesses provided their investors and potential investors with a lot more transparency when compared with publicly-traded companies. This access to detailed information would allow Blackstone to scrutinize investment opportunities more closely.

Since Schwarzman and Peterson had very little experience in the private equity industry, investors were initially hesitant about giving them money to launch their first fund. The duo decided to operate as a mergers and acquisitions advisory boutique for the next few years in order to build credibility. One of the company’s most notable accomplishments occurred in 1988 when Blackstone advised CBS Corporation (CBS) on the sale of its subsidiary CBS Records to Sony Corporation (SNE).

Schwarzman successfully raised $800 million in 1987 for Blackstone's first private equity fund, Blackstone Capital Partners I, L.P. Prudential Financial Inc. (PRU) and General Motors Company (GM) were two of the fund's largest investors. The money raised was used to purchase companies using a strategy called leveraged buyouts. (For more, see Understanding Leveraged Buyouts.)

Private equity funds are typically formed as limited partnerships. Outside investors, who play a non-active role, contribute to most of the partnership's capital. They are also known as limited partners. The general partner, who in this case is Blackstone, contributes a rather small amount of money to the partnership and is responsible for allocating the pooled money into a number of different investment opportunities. As a result, the general partner receives a management fee, which is normally a percentage of the total assets in the partnership as well as a percentage of the profits realized. (For more, see Limited Liability Partnership (LLP): The Basics.)

For instance, say that Blackstone uses the industry standard fund management compensation structure of 2% of assets under management and 20% of profits. If Blackstone manages a limited partnership with a total asset base of $500 million that realizes a $150 million return in a given year, it would receive $40 million in fees —  2% of $500 million plus 20% of $150 million. Blackstone would also make additional money on the actual capital it invested in the partnership. (For more, see Private Equity Management: Fees & Regulation.)

Since inception, Blackstone has raised more than $49 billion dollars for its seven private equity funds alone. Michael Stores Inc. (MIK), Equity Office Properties Trust and Hilton Worldwide (HLT) are some of the firm's popular acquisitions. According to Schwarzman's presentation at Yale, his private equity funds realized an annual average return of 23% from 1988 to 2008,. (For more, see Private Equity's Returns Are Tempered By Its Risks.)

Since launching his firm's first private equity fund in 1988, Schwarzman has significantly expanded Blackstone's business segments. The company continues to provide mergers and acquisitions advice as well as private equity fund management. In addition, Blackstone manages a number of funds of hedge funds and real estate investment partnerships. In 2012, Schwarzman's real estate team acquired just under 50,000 single-family houses across the United States with the hope of turning them into rental property.

Schwarzman took Blackstone public in 2007. The initial public offering raised more than $4 billion. In 2014, it was reported that Schwarzman received $690 million in Blackstone dividends alone. According to Forbes, his net worth stands at $11.5 billion.

Stephen Schwarzman became a billionaire by managing money for other people. Dissatisfied by the level of transparency offered by the stock market, Schwarzman co-founded The Blackstone Group, a private equity firm, in the mid 1980s. Today, Blackstone is the world's largest alternative asset manager. The company collects fees for managing hundreds of billions of dollars for a number of institutional investors.