Humiliating loss forces rethink of Blackstone's investment process
More than 40 years have passed since I founded Blackstone in 1985. Of all that has happened since, three episodes have remained with me. In a sense, they are my life itself.
The first was a grave stumble on the firm's third investment. It was a failure, but one that became the foundation of the success that has endured to this day.
In 1989, Blackstone acquired Edgcomb, a steel-distribution business. The investment collapsed and we lost every dollar we put into it. Steel prices fell sharply, and within roughly six months of our investment, the business ran aground.
The anger of the clients who had entrusted us with their money was immense. The chief investment officer of Presidential Life, an American insurance giant and leading backer of buyout funds, summoned me to his office after Edgcomb blew up. He screamed at me. I no longer remember the words. What I remember, vividly, is how loud his voice was.
It was an excruciating experience. I had talked confidently. I had said, in effect, "We will do this well," and then I failed. Filled with shame and contrition, I felt tears rising in my eyes. And there, in my heart, I made a vow: We were never going to lose money again—not while I was in charge.
The mistake was of my own making, which meant I had to correct it myself. What had I got wrong? As I reflected on the question, the answer emerged. We did not have a process that forced us to value investments dispassionately, to weigh both opportunities and risks with equal rigor.
We had no experience investing in the steel industry. One of our new partners, after analyzing how Edgcomb made its money, warned that all of its profits depended on rising steel prices. If the market turned, he said, the consequences would be disastrous.
But I sided with another young partner we had hired from outside—the partner who had brought us the deal in the first place. He had worked with Edgcomb for years at his previous firm and knew the company well. My error was to give too much weight to that experience.
From that point on, I overhauled the way we approved investments. Every proposal would have to go before a committee of all the senior partners in the form of a detailed written memorandum. The memo had to be circulated two days before the meeting, giving the partners time to mark it up, identify gaps in the prospective investment and sharpen their questions.
In the committee room, partners were expected to take an aggressive posture. The assumptions behind the analysis had to be questioned, probed and stress-tested without mercy. There was no sitting silently on the sidelines. Everyone present had to speak. Everyone had to assume 100% responsibility for the investment. Almost invariably, the proposing team would encounter questions it could not answer. The proposal would then be sent back. The team would return for a second meeting, sometimes a third.
This process of inquiry meant we never rushed a decision. By the time it had run its course, the investment proposal was far stronger, more disciplined and more firmly grounded than it had been at the outset.
Naturally, anyone whose proposal is rejected is disappointed, but there has never once been resentment. The more questions we pile on, the more the proposing team itself stands to learn.
The purpose of these tough interrogations is not to humiliate the person who comes up with an idea; it is the opposite. The goal is to protect the person making the proposal, the team, the firm and, above all, the clients. In the asset-management business, clients only get truly upset when you lose their money.
People do not learn very much when things are going well. That is why the Edgcomb experience, painful as it was, proved so valuable. Had we continued to repeat failures like that, we could not have remained in business.
On the desk in my New York office, I placed an object connected with the Edgcomb acquisition. It was a "tombstone," a commemorative plaque given to participants in a deal. Ordinarily, such plaques are keepsakes, trophies of a transaction completed. I had mine made larger than usual and painted black, the color of death. Every day I would glare at it and ask myself: What else are we doing that might not work out well?
After several decades, the tombstone disappeared from my desk. But it still exists inside my head, issuing the same warning it did back then.