Careers in Finance: Private Equity

Private equity is an ‘alternative’ asset class that invests in no-publicly traded entities. The sector has grown rapidly during this low interest rate era and stood at $3.8 trillion of assets at the end of 2014 according to Preqin.1 There is also an estimated $125 billion in “dry powder” waiting to be invested by private equity (PE) firms. But the space has gotten very competitive as a lot of liquidity is chasing a limited number of opportunities.

The strategy of these funds is nothing new. In the 1980’s private equity firms went by a different name, leveraged buyout funds, or LBOs. An example is KKR’s 1988 takeover of RJR Nabisco made major headlines and was chronicled in the book Barbarians at the Gate. This controversial deal left the term LBO with a negative connotation and today they’re just called private equity.

What is a Private Equity Fund?

Private equity funds are pools of capital that invest in non-public companies or areas. These areas can range from Silicon Valley startups to a struggling airline to timberlands. Private equity funds invest in both the equity and debt of these privately held companies and often employ large amounts of leverage (borrowed money) for these investments. The PE firm charges investors a fee for investing in the fund, often 2% of assets under management and 20% of the profits.

Private equity investments are typically illiquid, with 3-5 year holding periods. The end goal, called the ‘exit’, is often to sell the company via private sale or through an initial public offering. For example, venture capital firm Andreeson Horowitz was a private investor in Groupon who took that company public.2 Sometimes, private equity firms see value in publicly traded companies and can actually take them “private”, in the case of Dell Computers in 2013 by Silver lake Partners.

Private equity funds can invest in essentially any private companies in the world. Private equity funds generally target a couple different types of targets, growth companies and distressed entities. Buying up and restructuring distressed debt (often the debt is later converted into equity). A significant value add for the company is the key relationships the PE firm has within the industry. These contacts will allow the company to ramp up faster and cheaper.

Growth capital in private equity

When private equity sees growth potential in a young, innovative company they can take equity (or ownership) stakes with their capital investments. Private equity also encompasses venture capital and angel investor firms. These are the Silicon Valley start-ups you read about in the paper. Private investing in tech start-ups has been extremely popular over the last few years. The rise of unicorns such as Uber and Snapchat (startups with private market valuations of at least $1 billion) is a testament to this. It can also be a wary sign that there’s too much easy money chasing too few ideas, pumping up the valuations. But that’s for the private equity firms to decide.

Working capital in private equity

Private equity funds also deal with distressed companies. These might be capital intensive businesses with large overhead costs and overbearing debt in desperate need of capital to stay solvent. P/E companies provide restructuring and turnaround expertise to these companies. Perhaps the PE firm feels the company’s current management has been the source of the problems and will take over the company and replace management. If the debt burden is the real issue, it can typically restructure the debt through its network of associates.

Often times this can save jobs. In fact, the PEGCC cited a 2007 Ernst & Young study finding that 8 out of 10 private equity portfolio companies sustained or increased employment over time. Some disagree and argue that the restructurings cost jobs.1 During the last Republican primary, Newt Gingrich accused Mitt Romney, the founder of private equity giant Bain Capital, of “looting companies for short-term gain.”3

Who Invests in Private Equity?

Institutional investors usually are the main investors in private equity funds. Pension funds, charitable foundations and endowments are attracted to private equity for the diversification benefits and above average returns. In fact, public pension funds have allocated 9.4% of their total investments into PE which have returned 12.3% annualized over the past 10 years according to the Private Equity Growth Capital Council.4 As an alternative asset class, it is generally uncorrelated with traditional stock and bond portfolios. The illiquidity of private equity doesn’t deter these investors because their time horizon is longer than an individual investor’s. Direct investors such as these institutions in a private equity firm typically become limited partners as the PE firm itself is a general partner.

Individual investors also invest in private equity. Accredited individuals can directly invest and become limited partners themselves. Some private equity firms have themselves gone public and regular mom and pops can invest in these securities. Also, there are a few mutual funds and ETFs that invest in private equity. The earnings of the particular securities track the underlying businesses of the private equity firm’s portfolio companies or it may be more tied to the management company which charges and receives the fees.

What are the Different Careers in Private Equity?

There are many people involved in a private equity fund, including administrative staff and ancillary personnel. Here is a list of some of the professionals that work directly in the firm.

Associate in private equity

Usually coming out of business school with an MBA or a Master’s degree in finance, this is the entry-level positions for professionals in a P/E fund. You will assist the due diligence process by vetting opportunities and reporting the projections to senior members of the firm. This could be anything from digging through documents and financials to preparing letters of intent and roadshow presentations. As an associate, prepare to spend many hours modeling on spreadsheets doing cash flow analyses and capital budgets using different assumptions. The point is to select projects or target companies that can generate strong potential returns.

Consultant in private equity

You aren’t typically considered a consultant until you have a graduate school business degree-either an MBA or a Master’s degree in finance5. Here you spend a significant portion of your time actually working with the client (target firm) conducting interviews and running focus groups in an effort to build the right plan of action. Since you are meeting with the clients, there is now a significant amount of travel involved. You also act as a key mentor to younger team members.

Principal in private equity

Principals may be thought of as junior partners because they typically begin to have an equity stake in the fund through the ‘carry’ (carried interest). Many Principals manage their portfolio of companies. Ongoing monitoring is an essential part of the process since so much of private equity firms capital is invested in these companies. Consequently, they have a real vested interest in helping the companies succeed and manage accordingly. Many Principals also lead pro bono projects and begin to seek out and serve on non-profit boards to make a social impact.

Partner in private equity

This is the highest level one can attain in a private equity firm. Partnership is about maintaining client relationships and personifying trust. Partners meet with client senior management and potential client’s management. The partners all have carry in the fund and make the decisions. Partners are often promoted from within but on rare occasions can be brought in from outside firms. Many partners are an expert in one particular industry and often speak at conferences and are quoted in media outlets.5

What’s the Compensation at a Private Equity Fund?

The compensation packages at private equity firms are some of the highest in finance and the numbers are difficult to find. Compensation benchmarking firm Emolument revealed a study showing that Associates at private equity firms total compensation was $205,000.6 Another study showed the median pay (base salary plus bonus) in the private equity industry is about $235,000 according to the 2015 Compensation Report by SumZero (the report acknowledges that the numbers are heavily weighted towards New York City area responses).7 Obviously, the further up the ladder you get the more if your compensation is made up of carried interest. In good years, this can be in the millions of dollars for more senior professionals. But before you get too excited about this compensation, you have to land a job at a private equity firm.

How do I get Hired by a Private Equity Fund?!

Private equity funds attract the best and the brightest in finance. Getting a job at a private equity fund won’t be easy, even with 3,883 private equity firms headquartered in the United States, according to the PEGCC.¹ You certainly need a bachelor’s degree and having an advanced degree or designation certainly increases your chances. Work for a couple years and go back to graduate school for an MBA or a Master’s degree in Finance. While at school, try and land a spot in a summer internship program. Show junior level associates a potential company in need of expertise. This will show them you’re serious and you might have what it takes. Perform well and there’s a good chance you’ll get offered a full-time position.