1. Overview of this Career Area (“why”)
Private equity funds
Private equity is sometimes confused with venture capital because both refer to firms that invest in private companies and exit by selling their investments in equity financing, for example, by holding initial public offerings (IPOs). However, there are significant differences in the way firms involved in the two types of funding conduct business. Private equity invest in established, high-growth business whereas venture capitalists invest in early-stage, high-risk startups and businesses.
Private equity funds are pools of capital to be invested in companies that represent an opportunity for a high rate of return. They come with a fixed investment horizon, typically ranging from four to seven years, at which point the PE firm hopes to exit the investment profitably. Exit strategies include IPOS and sale of the business to another private equity firm or strategic buyer.
- Private equity jobs are some of the most desirable in finance, so competition can be intense.
- Private equity funds invest in large companies that are not yet listed on public markets.
- Senior private equity professionals are paid salaries, bonuses and carried interest—a proportion of the profits made when an investment is sold. Carried interest can be huge (20% of the total gains on the investment).
Private equity
Private equity is a vast industry covering a range of investment firms, from global companies like Blackstone, KKR and The Carlyle Group to hundreds of smaller players that specialize by geography or sector, such as Vitruvian Partners, Sovereign Capital or Bridgepoint. The biggest firms tend to operate beyond just private equity and invest in asset classes like real estate and credit as well.
Fundamentally, private equity firms, also known as general partners (GPs), raise money or equity from investors, which are known as limited partners (LPs). These limited partners include big pension funds, or the offices of wealthy families or individuals. The private equity firms invest the money they raise in buying private (unlisted) companies. Private equity firms then operate these companies alongside the existing management team, known as a management buyout. Having acquired a company, they (ideally) improve the way it operates before either floating it via the stock market or selling it to another private equity firm or a big corporation. At this point (the exit), they return the limited partners’ original investment, plus the additional return they’ve made, after keeping some of the extra for themselves. This extra is paid to senior staff as carried interest, which receives favorable tax treatment. Private equity firms also make money by maximizing the amount of debt (or leverage) on a deal.
Leveraged buy-outs (LBOs) are deals where a private equity firm targets mature and stable companies using a little of the private equity firm’s own cash (or equity) and a lot of money they’ve borrowed from other sources, including bank loans.
Private equity firms
Historically, most private equity firms like to recruit junior talent from investment banks. This is because banking juniors have completed a two-year training program and have a good grounding in the fundamental aspects of financial modeling, pricing companies, and mergers and acquisitions (M&A).
For this reason, a first job in an investment bank is still the best launchpad for a private equity career. Another way into private equity is by training in transactions services with a Big Four accountancy firm or by doing private equity commercial due diligence in a strategy consultancy.
Working in private equity is all about analyzing good business investments, and then beating the competition to acquiring an asset. This might be through direct negotiation with a company that a PE firm has identified as a good target to purchase, or through a formal auction process run by an investment bank that’s selling a business to a group of competing buyers.
There are similarities to working in private equity and to working in M&A (and this is why junior M&A bankers often move into private equity). However, as a private equity professional, you’ll be the one instructing the bank and the person actually doing the deal.
Skills, salaries & bonuses
Skills wise, investment banking candidates will already have a basic grounding in finance, and be able to read balance sheets and understand how companies are valued. Strong analytical skills are essential.
But private equity firms are also looking for ultimate all-rounders: people with insightful thinking and the ability to build relationships. Candidates should be confident and persuasive but also hard-edged when it comes to negotiating. They sell with their eyes and mouths and buy with their brains. It’s all about winning the deal.
Alongside this, you’ll need to be interested in how businesses work, rather than simply sitting behind a desk and looking at numbers, although there is an element of that as well.
When it comes to salaries and bonuses, private equity firms usually pay slightly below or on a par with investment banks—and like banks, salaries and bonuses vary significantly depending on the firm in question. The real money is not in the annual compensation, but in carried interest, which usually goes to professionals from around principal upwards (although some firms pay carried interest earlier). “Carry” is derived from the profits that are made on the LP’s original investment and is typically 20% of the returns (once a predetermined hurdle rate has been met).
Venture capital
Venture capital is financing given to startup companies and small businesses that are seen as having the potential to generate high rates of growth and above-average returns, often fuelled by innovation or by carving out a new industry niche. The funding for this type of financing usually comes from wealthy investors, investment banks and specialized VC funds. The investment does not have to be financial, as it can also be offered via technical or managerial expertise.
Getting into venture capital isn’t easy, though. Many try, and many fail. The venture capital industry is professionalizing as it expands and matures, and as a result, funds are becoming pickier about who they recruit.
VC funds are typically engaged in four things:
- Trying to find new investments (sourcing).
- Analyzing potential investments.
- Trying to win investments over other venture capital funds, and then…
- Trying to support companies once they’ve invested in them.
To work in venture capital, you will need to be good at least one of these things.
Key Differences between Private Equity and Venture Capital
A private equity firm’s strategy is to buy mostly mature companies that are already established. Private equity firms buy these companies and streamline operations to increase revenues. Venture capital firms, on the other hand, mostly invest in startups with high growth potential.
Private equity firms mostly buy 100% ownership of the companies in which they invest. Venture capital firms invest in 50% or less of the equity of the companies. Most venture capital firms prefer to spread out their risk and invest in many different companies.
Private equity firms usually invest $100 million and above in a single company. These firms prefer to concentrate all their efforts on a single company, since they invest in already established and mature companies. The chances of absolute losses from such an investment are minimal. Venture capitalists typically spend $10 million or less on each company, since they mostly deal with startups with unpredictable chances of success or failure.
Private equity firms can buy companies from any industry, while venture capital firms tend to focus on startups in technology, biotechnology and clean technology—although not necessarily. Private equity usually hires investment bankers, whereas venture capital firms usually hire consultants or tech experts.
Alternative Investments
An alternative investment is an investment in assets different from cash, stocks and bonds. Alternative investments can be investments in tangible assets such as precious metals, real estate or wine. In addition, they can be investments in financial assets such as private equity, VC, infrastructure funds, real estate funds, distressed securities, crypto currencies and hedge funds.
Generally, alternative investments tend to show a low correlation with traditional investments (stocks and bonds). In addition, some alternative investments involve extremely complicated valuation and are highly illiquid. Due to such reasons, certain types of alternative investments are quite popular among financial institutions and high-net-worth individuals.
Alternative investments may be a great addition to an investor’s portfolio. Many alternative investments provide significantly greater returns relative to traditional investments. Also, the availability of a wide range of alternative investments makes them a viable option despite the investor’s risk tolerance or perceptions of the market.