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Private Equity

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As the name suggests, Private Equity firms invest in private companies (or a company not publicly traded in the stock markets). Furthermore these investments are exclusively equity investments, meaning they buy a percentage of a company.

 

Usually PE firms aim to buy a controlling share of the company (an amount of equity which puts them in charge of the company’s decision-making). They usually aim to buy more than 70% of a company, but depending on the situation it could be a bit less (almost always more than 50%).

 

A PE company often buys a company, tries to improve it somehow, then sells it some number of years later (5-10 years) for a profit. There are many different types of private equity investments, such as Venture Capital, Growth Equity, and Leveraged Buyouts (LBO). This page focuses on PE firms that do LBOs, since careers titled “Private Equity” tend to be at these types of companies. We will explain what an LBO is in more detail later on! 

 

Keep on reading below to understand PE careers within just minutes.

What Do Private Equity Firms Do? 

While the type of company you might buy depends on the type of PE firm you are at/what they specialize in (i.e. Tech Industry, Healthcare Industry, etc), the goal of someone in PE is always to buy a company for a good price, improve the company somehow over the years to generate greater profit (while you own the company), then to resell the company for a profit some years later.

What is a Leveraged Buyout (LBO)?

An LBO is when a PE firm buys a company using debt. Usually, the steps go as follows:

Why is this a good idea? If you notice, the PE firm only put up a very small amount of its own cash (while raising most of the money via debt/loans, aka money from other people). After a number of years, the acquired company pays off the debt (for the PE firm) using its own cash flow. And now the PE firm effectively paid a very small amount to own a majority of this company! LBOs allow PE firms to buy companies for cheap and return a large profit down the road.

Simple/Real-Life Example

Below is an example of a process whose mechanics are similar to a LBO:
  1. If Johnny wanted to buy his friend’s lemonade stand because he’s confident that it would make a lot of cash. 
  2. Johnny could raise money to buy the lemonade stand by taking out a loan (or debt).
  3. If Sid believes in Johnny’s ability to pay him back he might give Johnny a loan for $100. 
  4. In exchange for giving him this money upfront, Sid requests that Johnny pay him interest payments for a predetermined length of time, until he ultimately needs to pay him back in full (the original $100 “principle” payment). 
  5. Sid tells Johnny that he wants to receive a $5 monthly payment (interest payments), for one year, and must receive the original $100 at the end of the year.
  6. Now that Johnny raised $100 from debt, he pays $20 himself, for a total of $120, to buy 100% of the lemonade stand. 
  7. If Johnny makes $20 monthly, selling lemonade, he can use that profit to pay his interest payments ($5 every month to Sid). 
  8. After the 12 month period, Johnny still has $15 x 12 months = $180 of cash leftover from the profit the lemonade stand provided him (since $20 per month – $5 to Sid = $15 of monthly profit). 
  9. Johnny pays Sid the final $100 he owes from his loan and is left with $180 – $100 = $80 and a lemonade stand. 
  10. Now, he might resell the lemonade stand, for $140 (slightly more than he paid one year earlier). 
  11. After this entire process, Johnny paid only $20 of his own money for this investment and “exited” the investment with $140 + $80 = $220. Not a bad return!

Private Equity Example:

  1. PE firm needs to find an investment opportunity. In order to do this, they find a potential company to buy through connections they have, internal research, cold calling attractive companies, an Investment Bank approaches them via a “public auction” for a client they are trying to sell, etc.
  2. Investment teams begin their due diligence process, which includes industry research, speaking with advisors about the company and building the first draft of financial models to find a good purchase price for Company X. Furthermore you build LBO models to project the expected return on this investment years down the line.
  3. Speak with Investment Banks to see how much debt they want to give you for this specific purchase.
  4. Offer Company X your First Bid (offer to buy) and a Letter of Intent (LOI). A LOI is a non-binding agreement, which outlines details about the purchase and what needs to be done to complete the deal.
  5. PE firm builds an operating model, which breaks down revenue projections and costs for Company X, after the purchase occurs. This helps the PE firm get a better idea of what their return on investment (ROI) projections look like.
  6. The PE firm’s investment committee approves the Preliminary Investment Memorandum (PIM), which includes necessary details of the investment and Company X.
  7. Then, they approve the Final Investment Memorandum (FIM), which contains things like the final/specific valuation or purchase price for Company X.
  8. Lastly, the PE firm offers the final binding bid to Company X and signing takes place.

Private Equity Firm Behavior After The Purchase:

The PE firm usually retains ownership of Company X for 5-10 years. During this time, they use profit generated from Company X’s business to pay off the debt they raised from the Investment Banks (step 4 above). Throughout the, say, 5 year span, the PE firm works with Company X and makes sure they are making a consistent profit. This is important because a) this profit ideally pays off the debt b) If Company X becomes a better run company, they are more valuable and can be resold for more profit by the PE firm.

Who does what at a PE firm?

  1. Associates – the junior level employees, usually are responsible for the number crunching via financial modeling. Additionally they do a lot of the initial due diligence for investment opportunities and help with management of portfolio companies (companies the PE firm currently owns).
  2. Vice President-level (VP) – usually manage the daily responsibility of the deal teams and work closely with more senior people at the firm on strategy and negotiations. Additionally, they are expected to bring in potential investment opportunities.
  3. Managing Directors (MD) & Senior Partners – are the decision makers and work very closely with the investment committee. Additionally they are usually the ones communicating frequently with management at portfolio companies, target companies, Investment Banks, etc. They handle most of the negotiations and also are responsible for sourcing future deals (as everyone is).

What is the difference between Private Equity and Venture Capital?

While PE firms and VC firms both partake in “private equity investments” the way they function are a bit different. Below is a breakdown of some general differences between the two:
 
VC v.s. PE
 

What types of Private Equity Jobs are out there?

Private Equity Recruiting is a bit more straightforward than some other finance roles. Most PE firms recruit those who already completed a few years of Investment Banking and/or have experience at another PE firm.

The most common types of PE firms sometimes are bucketed into the follow categories:

  • Lower Middle Market – Invest in smaller companies, typically with valuations between $25mm and $100mm.
  • Middle Market – Broader range, but typically invest in companies with valuations between $25mm and $1 billion.
  • Large Cap – Invest in larger companies, with valuations of roughly $1 billion +

Some general examples of tools/methodologies someone in Private Equity might use

  • LBO Modeling – A model created to assess the transaction and earn the highest possible return. Need to analyze many things like, how much debt you use to buy the company, when you would like to exit, etc.
  • Diligence – Looking up details on a company and/or the industry they are in.
  • Powerpoint – Used to create presentations for the target company
  • Excel – Used to build Financial Models

What types of skills, mentality, etc. are necessary to be successful in Private Equity?

  • Self-learner – Junior level employees at PE firms are certainly number crunchers but they often take on other responsibilities as well. Learning quickly is essential to becoming a valuable part of the team.
  • Self-motivated – Many of the responsibilities require you to actively look to learn, contribute and/or help the team find potential investment opportunities.
  • Modeling skill/background – PE firms usually recruit individuals with Investment Banking experience because they have a few years under their belt and have some financial modeling experience.
  • Good communication skills – When working on slightly smaller teams it is essential to communicate effectively in order to get things done. Additionally, PE firms constantly communicate with management from their portfolio companies and their target companies (companies the wish to buy); communicating well with these parties can make or break an investment opportunity.

What are some challenges of working in Private Equity?

  • Tough to break into the industry; usually need at least two years of Investment Banking experience to get into Private Equity
  • Sometimes there are few opportunities to advance, since the senior partners aren’t going anywhere. So junior level employees might get stuck at a certain seniority-level.
  • Work can be stressful and long hours, especially when you have an active deal happening.

What are some benefits of working in Private Equity?

  • Well compensated. Large base salaries and bonuses. Often have “carried interest” as well, which means that you share the profits of the firm (available at more senior levels usually).
  • Work closely with CEOs, COOs, CFOs, management, etc. of companies. Can help transform a business and gain exposure to exciting business operations.
  •  A lot of different responsibilities – from financial modeling, to industry/company due diligence, to working closely with management of different companies. Can learn a lot about many different things.

Typical Salary?

According to wall street oasis, a typical PE compensation progression looks as follows:
  • First Year Analyst/Associate: $100K – $250K
  • Second Year Analyst/Associate: $150K – $300K
  • Third Year + Analyst/Associate: $170K – $350K
  • Vice President: $300K – $800K
  • Managing Director/Partner: $500K – $10MM+

What are some exit opportunities for someone in Private Equity?

The exit opportunities in Private Equity, for the most part, are pretty broad. Anything on the “buy-side” (Venture Capital, Hedge Funds, Family Office, other PE firms) is fair game, along with any business related role.

Additionally, it is common to go back to business school and get your MBA. Once you are in Private Equity, your path might look something like this:

  • After two years, get an MBA and return to Private Equity (can be the same firm, or a different firm). You usually return to PE as a VP, at this point.
  • Or, you can get an MBA, and go into a corporate strategy/development role and be more involved in the operations of a business.

Should I go into Private Equity?

Private Equity is one of the most highly coveted jobs on Wall Street. Besides its high compensation, the work is generally viewed as exciting and less repetitive. People often “sacrifice” two years in Investment Banking just so they can enter the world of Private Equity. If you enjoy analyzing companies, learning about different industries, and seeing different ways to improve the operations of a more mature business in order to increase profit, efficiency and cash flow, Private Equity might be something you want to consider.

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