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Private Equity firms are an increasingly important part of the economy and offer some of the most sought after careers in finance. By private equity we are referring to the activity of purchasing all or part of the equity of companies away from a normal stock purchase in the public equity markets. We separately discuss the closely related career opportunity in venture capital - the activity of investing in small, early stage companies.
Private equity firms control close to a trillion dollars of capital and get involved in leveraged buyout transactions, partial stake purchases in public companies and investments in private companies. The largest firms in this sector are both visible and extraordinarily adept at using the tools of finance to design wealth-creating transactions. The leading private equity firms include Blackstone, KKR and TPG. There are hundreds of other firms as well that engage in “middle market” transactions – smaller deals.
Leveraged buyout transactions normally target mature cash flowing businesses that have fallen in some disfavor or, alternatively, divisions of corporations that are put up for sale. An LBO investor looks for predictable cash flows that are essential to make interest payments on debt.
Private equity firms are normally organized as partnerships with general partners (the principals of the private equity firm) that provide the brains and transaction expertise and limited partners that provide the capital. Warburg Pincus, for example, is on its 10th private equity fund and is investing $15 billion from that fund. Limited partners have found this a good area to invest in as the returns have been high and the time horizons of funds well suited to them. Typical limited partners include university endowments, insurance companies, corporate pension plans, public employee retirement plans and high net worth individuals.
The entry level job in private equity is as an analyst (undergrad) or associate (recent MBA or masters). You would typically be involved in a combination of four activities: (1) spreadsheet analysis of the economics of a potential leveraged buyout, (2) sourcing of new deals through industry research and screening of potential buyout candidates, (3) preparation of materials for a senior partner on a potential investment target or company already subject to investment or (4) coordination of the many diligence and research items required to carry out a transaction. The work is detailed, interesting and demanding. Hours can be long and emotions can get frayed as you adapt to both the circumstances of a deal and the vagaries of those around you. You will get an opportunity to interact with numerous law firms, bankers and consultants as you pull together the work on projects. You will soon become an expert on the debt markets – in particular, the arrangement of syndicated bank loans and high yield bond “take outs” that are used to refinance loans in buyouts. The work can be heady stuff as you will interact directly with CEOs and their management teams often even while you are at a junior level. The experience of how the business world works at a high level can prove invaluable in your future career.
Key skill requirements for a job as a private equity associate include:
There is a lot of financial upside in this business because the rewards of success can be extraordinary. A private equity firm that keeps 20% of its profits as carry (plus management fees) can pull down over a billion dollars in profits for its principals in a good year. Obviously, this leaves ample room for all involved to have high compensation. There is also substantial downside and as we write this summary in August 2009 the financial markets are starting to recover from a significant downturn. As you might expect the downturn has negatively impacted the private equity industry because access to debt has been challenging. An LBO transaction could have been financed in 2007 with debt equal to eight times cash flow. Today, getting four times debt cash flow on a transaction is an accomplishment and then the debt will be far more costly. To complicate matters, many major limited partners (e.g., university endowments, state pension funds, foundations) have found themselves overweighted in illiquid assets which is making it more difficult for private equity firms to draw down capital for investments. It is worth bearing in mind that this has happened before. The private equity industry took was hit hard by economic malaise in 1982, 1991, 1995 and 2001. In each case, the industry both recovered and went on to ever greater heights. It is more likely than not that the private equity sector will grow ever larger in the decade ahead.
To elaborate further, we have noted that the largest private equity firms are involved primarily in leveraged buyouts (LBOs). There are some other focus areas that might interest you. These include (1) providing equity to firms that have begun to generate revenue but still require capital to increase growth (growth equity); (2) providing mezzanine debt - debt that is subordinated to bank debt and generally the last stop in the capital structure before equity; (3) participating in secondary funds that purchase private equity interests that are traded; (4) participating in funds that invest in other funds (fund of funds) and (5) investing in turnaround situations – companies that are troubled or bankrupt and need crisis management. Some private equity firms like Cerberus get involved in every stage of the business: venture capital, growth capital, buyouts, mezzanine investments and turnarounds. Others stay focused on just one area such as middle market buyouts (Riverside is a good example). It is very difficult to break in to private equity coming with a recent undergraduate or MBA degree.
The state of the markets is not helping. The jobs are not plentiful and private equity firms prefer to hire persons with a few years of experience. The typical starting point for a private equity career is a job as an analyst or associate in an investment bank. The best private equity firms tend to hire out of the best banks. The search is on for high quality bankers who have their share of deals worked on (memorialized by a nice group of “lucites” – mementos of deals done). There is also some recruiting out the better management consulting firms. However, MBA students are recruited into this sector, particularly from the top finance-oriented business schools (Chicago, Harvard, Stanford, Wharton) and a smattering of bright undergraduate students find positions each year in private equity. Because few private equity firms are large enough to have a coordinated external recruiting effort, it is worth your while if interested in this area to carry out a self-directed job search. Many firms hire only episodically and recruiting success can be a matter of showing up at the right place at the right time with the right story. We encourage you to try this approach. Follow the time-honored path of networking and using a little shoe leather to make connections with persons that can help you break into this exciting industry. Ideally, your networking activities will take place well before you hit the job market at graduation. You should be looking to meet people in the private equity industry along the way. A few friends can go a long way in finding the job you want.
Good luck as you contemplate a private equity career!
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The compensation in private equity reflects the elite nature of the work. You will generally earn more than would be available in virtually any other area of finance. A typical college graduate in private equity will earn $90,000 the first year out of school and a typical MBA will earn close to $200,000. The median starting salary and signing in bonus was $145,000 in 2008. At the mid-career stage (2 to 4 years out of MBA) the compensation runs from $300,000 up to $800,000. At the top ranks, the better players routinely earn sums in the $3 to $10 million range. Pay in top ranks generally comes in the form of participations in transactions and you will make the most when a transaction that you work on generates a high return.
An important factor in private equity compensation is the extent of participation in a company’s profitability – the “carried interest”. Most associate positions do not provide for participation in the carry but once you make principal or junior partner you should expect to have a piece of the carry, albeit maybe less than a percent. As you progress from principal to mid-partner, senior partner and then managing partner you will see your participation in the carry rise ultimately to 5% to low double digits.