What is Private Equity?

What is private equity? Regardless of your career path or job function, it’s likely you’ve heard someone talking about “private equity.” Perhaps a friend has made a pretty penny working for a private equity firm or you read an article about a celebrity whose wealth comes mostly from private equity investments.

Today, we’ll discuss the basics of private equity (“PE”), dive into the different types of PE, and look into different career paths in this competitive field. It may be more feasible than you think!

Private Equity Definition

First, let’s offer a private equity definition in a corporate context. Private equity is a source of investment capital not listed on a public exchange. If a company needs money to make an investment in people, material, or machines, it could sell stock to investors and have its company shares listed on the New York Stock Exchange. That would be public equity.

Or, it could receive an investment from a group of private investors who then gain a controlling ownership stake in the company. That is “private” equity. PE investors look to gain a controlling stake or notable minority stake in a company. These investors generally reap greater profits than what public equity markets have to offer because PE investing usually involves more risk.

Now, what do private equity firms do, exactly? The answer depends on the types of private equity and the investors involved.

Types Of Private Equity

There are really two types of private equity: leverage buyout funds and growth equity funds. A leveraged buyout fund is a type of private equity with the intent of securing controlling stakes in an established company, which can be done alone or in conjunction with other PE investors or firms. PE firms support these transactions through some equity capital, but also debt in the form of loans or mezzanine debt. This means that, as they take control of the company and invest their own firm’s cash, they also take out loans that the company must then pay back using its cash flow. Oftentimes, they are looking to increase their return on equity by using a lot of debt to complete the transaction. These firms’ financial success then result from a mix of improved company operations and savvy financial engineering.

Another private equity example is the growth equity fund model. In this domain, PE investors are investing in somewhat less established companies with better growth prospects. Oftentimes they are not seeking controlling stakes, but instead are looking to help scale operations so the company can enter new markets. Growth equity investors will usually throw money at companies across many different industries.

In both cases, PE firms tend to receive seats on a company’s board of directors and may install their own employees in key roles. In these ways, they influence the decisions a company makes, the processes it follows, and the strategies it pursues. In other words, they invest in the company and then try to improve its operations.

Private Equity Vs Venture Capital

Where does venture capital come into the mix? In thinking about private equity vs venture capital, there are several key differences. As previously mentioned, private equity is capital invested in a private company that is not publicly listed. Large institutional investors buy shares of private companies to gain control and influence operational and strategic decisions in the world of private equity. Venture capital, on the other hand, is a channel for funding to startups and other new businesses that show promise for future growth. Wealthy individual investors, VC funds, or investment banks provide either financial support or other types of assistance to young companies, such as managerial or technical expertise.

VC support is often critical to the success of a startup, whereas PE works exclusively with established companies. To summarize private equity vs venture capital, each serves a different niche of companies, and the amount of money invested and share of equity differs.

How To Get Into Private Equity

If you’re wondering how to get into private equity, working first as an investment banking analyst is a natural first step. Private equity firms know that investment bankers have the financial and analytical expertise needed to help them make sound investment decisions. But because private equity firms are smaller than investment banks, it can be challenging to break into the field. Knowledge of the investment world, risk, and other key factors are critical to landing a position at a private equity firm.

The lowest rung of the private equity ladder is the associate tier. This entry-level position generally requires at least two years of experience in investment banking. However, experience in management consulting or other fields where analytical and excel modeling skills are built can also be attractive to PE firms. Like the life of an investment banking analyst, an associate at a private equity firm can expect to work long work hours. Overtime is common, especially when closing a deal. But the pay, learning experiences, and career options created are generally very attractive.

Private Equity Jobs

Within the bottom rung of private equity jobs, there are junior and senior designations. Senior associates carry more responsibility and bigger checks to the bank at the end of the day. The next level is the vice president tier, and finally, the principal tier. If you’re thinking of working in private equity, this hierarchical path is the status quo across most firms.

Private Equity Salary

Private equity compensation is handsome regardless of position. The private equity salary for associates is $120-140k/year, plus a bonus of roughly 150% of salary, leading to a total $300-$350k annually.

You can compare PE compensation to consulting by looking at our Consulting Salaries Report here.

Key Private Equity Terms

Some private equity terms to be aware of:

• Limited Partner – a high net-worth investor
• General Partner – a manager of investments for a private equity fund, and the earner of the highest private equity compensation within the firm
• Preferred Return Clause – a minimum annual return rate for Limited Partners to receive before General Partners
• Committed Capital – money committed to a specific private equity fund
• Cumulative Distribution – the sum of stock and cash that’s paid out to Limited Partners
• Residual Values – the market value of Limited Partner’s remaining equity in a private equity fund

Private Equity Case Study

A private equity case study is the focal point of interviewing for an associate position at a private equity firm. While the details of case studies vary by firm, the nature is consistent. Candidates receive a copy of a Confidential Information Memorandum (CIM) and are asked to write up an investment memo along with a basic LBO (leveraged buyout) analysis.

Conclusion

Private equity is a lucrative landing spot for creative financial thinkers. However, keep in mind the demanding hours any PE job will require of you. If you’re looking to break in, consider working with our team to master the interview process.

 

Additional Resources:

• Financial Engineering: A New Consulting Frontier?
• Corporate Finance Consulting
• How Consultants Use Excel
• Pyramid Principle Applied