Private Equity Overview

1. What is Private Equity?

Private equity raises capital from accredited investors, to buy companies, and then sell them for profit. Private equity firms are directly involved in their portfolio companies’ operation to improve them, increase the value and to later sell them for profit through an M&A or bring them public through an initial public offering (IPO). 

The industry is called “private equity” because the firms acquire stakes of companies, bringing it private to improve them and increase their value. After that, firms sell the companies to other firms, or take them public. Private equity firms also don’t limit themselves to the private market. Some PE deals are takeovers of listed companies, called “take-private”.

1.1. How does private equity work?

Private equity firms raise capital from limited partners such as pension funds or insurance companies to invest in matured companies, typically those in distress, in traditional industries. PE firms often buy majority stakes (>50% ownership) of said companies, restructure them to improve profitability, then sell them for profit through an M&A (total exit) or bring them public through an IPO (partial exit).

The chart below shows how private equity firms raise funds from limited partners and invest in their portfolio companies:

Limited partners (LP) are institutional funds – such as pension funds, endowment funds, insurance companies, etc – and high net-worth individuals that committed capital to that VC. 

General Partner raises funds for the firm, decides when and which companies to invest in, and chooses when to exit the investment. 

Private equity firms will do everything from selecting investees, to managing and growing their businesses.

You may notice that there is a private equity fund in which both the private equity firm and the limited partner put their money. This is some sort of shell company that will acquire the target companies on behalf of the investors.

This “shell company” is created so that the private equity firms have basically no liability for their investments, legally speaking. This means if their investments fail and face significant debts, the shell company, or more accurately, the investees will have to pay out those debts. 

Firms often charge management fees of about 2% of the fund. This fee will be used to pay for operating activities in the firm. 

After an investment is liquidated, around 20% of the return will become carried interest. Most of them will go to the General Partners. The rest will be shared among partners, principals, VPs and associates.

80% of the return will be shared among Limited Partners according to their contributions.

1.2. Types of private equity

There are two ways to classify private equity firms: by assets under management (AUM) and by investment strategies. By AUM, there are mega-funds and middle market funds. By strategies, there are leveraged buyout PE, distressed PE, real estate PE, PE fund of funds and venture capital.

By AUM, the mega-funds are PE firms with over $5 billion dollars in their portfolio. The rest are called middle-market. Middle-market funds are further divided into upper-middle and lower-middle, though they are not clearly defined.

Private equity firms utilize various strategies as mentioned. Let’s go a bit into details:

• Leveraged buyout (LBO) private equity: the most popular type of private equity funds. They use significant amounts of debt for their acquisition (sometimes up to 90% debt, and just 10% of their own cash) to magnify returns. The acquired companies themselves are the collateral assets for the debt. 
• Distressed private equity: these funds seek and invest in companies in distress (whose value have significantly dropped) to change their operation and management, hoping that after the restructuring, the investees can be sold at a premium.
• Real estate private equity: these funds acquire, develop, operate, improve and sell properties for profit. Their main targets are commercial real estate, such as offices, industrial, retail, multifamily, rather than residential real estate.
• Private equity fund of funds: This type of fund invests in other funds. This means the funds pool money from their own limited partners, then invest in other private equity funds, mutual funds, or hedge funds as limited partners themselves. You may think “does this sound redundant?”. It kind of is, but they exist to offer a backdoor entry to an investor who cannot afford minimum capital requirements in such funds.
• Venture capital: this type of fund deserves to be its own category, but in the end it is still somewhat “private equity”. Venture capital firms invest and nurture promising start-ups, hoping that once they become successful, firms can sell them for massive returns. Firms expect most of their portfolio companies to fail, but even one or two successful start-ups can bring massive returns, making up for other losses.

2. Private Equity vs. Other Investment Funds

2.1. Private equity vs hedge funds

While private equity buys stakes of a company, hedge funds focus more on liquid assets that can yield returns in a short amount of time. PE tends to be more long-term, while HF can be flexible, and most of the time focus on short- and medium-term investments. HF also has no limit to their investment, from equities, bonds, to currencies and derivatives.

A common thing about private equity and hedge funds is that both raise capital from limited partners to invest, and their goals are similar, to exceed the returns of public markets. Private equity uses significant debt, while hedge funds also utilize financial leverage alongside raised capital to magnify what would be otherwise modest returns. The similarities stop here.

Private equity buys majority stakes of companies, restructures them to increase their value, and then sells them for profit. An investment may last from 5 – 10 years to renovate and upgrade entire companies.

Hedge funds deal with a much more diverse range of assets, from equities, debt, currencies and their derivatives. They also utilize complex analyses and algorithms to maximize returns and limit risks. You can say hedge funds are a kind of rich traders, and some of their investments are extremely speculative. 

HF also tends to buy and sell assets in short- to medium-terms to make use of price discrepancies. Holding for too long will be risky since the fund doesn’t actually own the underlying asset.

Career wise, an investment banker would more likely join private equity, since their skill sets align with each other: building models, pitching deals, etc, while hedge funds would be more suitable for traders, with experience in asset management or proprietary trading.

2.2. Private equity vs. venture capital

Private equity and venture capital are similar in nature: They both pool money from accredited investors to invest in companies, grow them and sell for profit, but they are fundamentally different in the type of companies they invest in, their investment stage, and stakes in their investees.

Private equity firms usually buy majority stakes (>50% ownership) of matured companies that are deteriorating due to inefficiencies, while venture capital mentors and provides rapid-growing companies with the necessary capital in exchange for a minority stake (<50% ownership).

2.3. Private equity vs. mutual funds

Private equity and mutual funds both pool money from investors to invest. The main difference lies in the assets they invest in, and the eligibility to become an investor.

Private equity exclusively invests in equities, or in other words, buys stakes of other companies, public or private, and only accredited investors like financial institutions or wealthy individuals can invest in private equity funds.

Mutual funds are more flexible: they can invest in equity & debt of publicly-traded companies, and almost anyone with money can invest in a mutual fund. 

Here’s a wrap up so you can get the overview:

5. Private Equity Salary and Compensation

A private equity analyst may earn between $100K – 150K, with no carried interest due to being the most junior position. Pre-MBA associates’ total compensation ranges from $200K to $300K, depending on firm size and personal performance, and carry is unlikely. Post-MBA (senior) associates earn a bit more at $250K – 400K with the carried interest, though this number is still really small.

Vice presidents can make $350K – 500K annually, with some carry. Principals earn between $500K – $800K, with additional carried interest. Partners can make millions per year, with carried interest in the multiple of that number, or nothing at all. They earn so much carry because they put their own money into the investments.

Salaries vary greatly among firms. Some may pay below that range. Some pay significantly higher. Here’s a wrap-up so you can get the idea:

6. Top Global Private Equity Firms

The largest private equity firms by assets under management are:

7. Private Equity Recruiting

Private equity recruiting is divided into two types: on-cycle and off-cycle recruiting. The annual on-cycle recruiting is for analysts at bulge bracket and elite boutique investment banks, especially those on Wall Street. This is the main way firms fill their workforce. Off-cycle recruiting is for everybody else.

7.1. On-cycle recruiting

Private equity on-cycle recruiting is reserved for analysts at bulge brackets and elite boutiques. A few months after starting their jobs at banks, analysts are approached by firms to see if they are interested in private equity. They are then interviewed and offered a position right away if they pass the interview round. On-cycle recruiting usually lasts one week and the process is intense. 

Here’s how the recruiting may take place:

Recruiting starts as early as July to October, a couple of months after analysts at bulge bracket and elite boutique banks start their jobs.  If you get the job offer, you can start working in the next 1.5 – 2 years. So if you get your offer in 2021, you will start your PE career in 2023.

The headhunters have more power on the associate on-cycle recruitment process compared to the off-cycle. After getting your resume, they will contact you and set up a telephone interview. Some common questions in this interview could be: “Walk me through your resume?”, “Why Private Equity?”, “Why this firm?”, etc. If you can impress the headhunters, they will pass your resume to the firms. They decide whether you can go to the next round or not, so you’d better be well-prepared and win them in the telephone interview. 

The PE firm then will invite you to a “weekend event”, the worst part of On-cycle recruitment. You will have four to five 30-minute interview sessions with people across all levels. If you succeed, the firm will call you back for an LBO model test. The results will come in a few days.  

The brutal thing is that you can’t have second thoughts: it’s private equity or nothing. You’re hesitant to leave your bank? Disqualified. You’re indecisive between private equity and hedge fund? Disqualified. And you have to decide on a job that you won’t do for the next two years. Who knows how private equity will change after that?

7.2. Off-cycle recruiting

Off-cycle recruiting is reserved for non-bulge-bracket and elite boutique analysts, positions outside of the US, and positions for non-bankers. It usually lasts a few months, and your “fit” and critical thinking will be evaluated with more depth. 

Off-cycle recruiting starts after the on-cycle process, from December to February. If you succeed, you can start after a few weeks instead of 2 years. 

However, if you apply for any vacancy that firms need immediately, you can start instantly. This kind of recruitment is more random throughout the year. 

Off-cycle recruiting usually lasts longer, and recruiters want to assess your “fit” and critical thinking abilities on deeper levels and they also require more thought and preparation of a real investment thesis. 

Headhunters have little power here but you can still try to reach out and check for vacancies.

8. How to Break into Private Equity

The traditional pathway into private equity is to work as an analyst for a bulge bracket/elite boutique investment bank, then join a private equity firm as an associate. Today, some firms hire analysts directly out of college, making private equity much more accessible to undergraduates. Still, the industry is extremely selective, and only the best can join one of the most lucrative finance careers.

8.1. From investment banking to private equity

This is the most common, and the easiest way to break into private equity. After joining a bank for a few months, firms will approach you and ask whether you’re interested in the industry. If everything goes well, you are offered a position and will start working in 2 years.

Everything you want to know about this is up there, on the Recruiting part.

8.2. From private equity internship to analyst

Recently, this path has become more popular with some mega-funds looking for fresh graduates for analyst positions. 

These summer analyst internships are extremely limited and very competitive. Like bulge bracket internship applications, you need to be a superstar with an outstanding resume (target schools might not even make the cut here), relevant experience, ideally at boutique investment banks & small private equity funds, and hardcore networking to get one of those interview slots.

This makes PE somewhat more accessible to undergraduates, but even that is an overstatement. You are still facing a whole lot of competition, with thousands fighting for a spot. It is indeed hard, but not impossible.

9. Private Equity Work-Life Balance

Many investment bankers exit to private equity because of the so-called “better” work-life balance, but the reality is not that better. At middle market funds, you still work for 60 – 70 hours a week, with occasional weekend work during deal times. At mega-funds, expect investment banking working hours. You will spend day and night at the office with frequent weekend work.

So is work/life balance better? In a way, yes. Private equity hours are slightly better than investment banking hours at equivalent level. But is it a drastic improvement? No. You may still come to work before sunrise and leave after sunset.

Your hours can also get unpredictable due to working on deals. And working in private equity (and buy-side in general) will be more stressful than sell-side, with a lot of money at stake.

10. Private Equity Pros & Cons

10.1. Benefits of working in private equity

• Big payday: Obviously the main reason why bankers leave their jobs for private equity in the first place. PE is one of the most lucrative finance careers, period.
• Interesting work-scope: In private equity, you get to be more involved with deals, gaining on-field experience, working with portfolio companies and learning about different industries, instead of just sitting around editing models.
• Better work-life balance: You won’t be working a 9 – 5, but around 70 hours of work every week is far better than 80 – 100 hours in banking. You’ll get more sleep, less stress, and maybe, enjoy your job more. 
• Easier advancement: PE firms have fewer staff, so politics is less of an issue. Your performance will be the most significant factor. The hierarchy is also flatter, and you’ll get to work with seniors right from the start. Perform well and impress them, you can easily move up the ladder.

10.2. Drawbacks of working in private equity

• Hours are still enduring: 60 – 70 hours a week is not a small number. You will still get up in the dark and go home in the dark.
• Co-investment: You have to re-invest into the firm at higher levels. This makes your carry significantly larger than others, but if your firm doesn’t do well, you take the most damage.
• Hard to get into: PE is basically reserved for analysts at top investment banks, and firms rarely hire anyone other than those. It’s even harder if you are a late-starter or a job hopper.
• You will still do a lot of financial modeling: This is kind of a drawback if you move to PE from IB expecting yourself to do something entirely different. But you will still be sitting at your desk building models and pitching deals. Those truly interesting stuff comes later as you move up the ranks.