Private Equity is a collective of investors who pool in their massive wealth to acquire stakes such as shares or some major financial involvement in a mature company.
The intent is to provide the capital to companies that need some form of overhaul – restructuring, change in management, workforce, operations, etc to reap more profits that are shared by the PE firm.
They can also be involved in buyouts where they essentially control the company, sometimes borrowing against the company as a leverage. More funds mean more buying power and more control and in turn more funds.
Unlike Venture Capitalists who invest in startups, PE only invests in big mature companies, dealing in nothing less than millions and billions. Famous PE firms like KKR, TPG, Blackstone control trillions of dollars.
The profits are shared between the two layers of partners in PE:
- General Partners comprising the business experts and investment professionals who are the fund management decision makers.
- Limited Partners are those that have provided the capital such as pension funds, institutions, high net worth individuals etc. They don’t participate in the day to day activities but rather invest their tons to gain on returns later.
How do private equity firms make money?
When we are talking about private equity firms, the kind of money that they handle and the revenue they generate are typically on another realm of finance.
With Venture Capitalists, the best ones generate a revenue in the millions, funding entrepreneurs set up their business concept.
With PE, take that up a notch and a few orders of magnitude higher. They manage billions of dollars in capital and their revenues are a handsome percentage of that.
To understand why and how PE firms make money, you need to realize that there’s more than one source. And unlike a standardized salary, there is quite an emphasis on earnings from profits that appear as bonuses for senior PE professionals.
Here are the basic three modes of revenue in PE firms.
Management Fees
These are the standardized pricing on services that firms charge both the Limited Partners and the portfolio companies that they handle.
On a deal that costs billions, the tiny portion of 1-2% management fees can be the million-dollar bread and butter for employees.
This is essentially the agreed upon salaries that are distributed no matter how the investments pan out.
Carried Interest
It is a percentage of the investment’s revenue shared by the GP and LPs. For fairness, these are often only awarded when a previously agreed upon benchmark value (usually 8% of return on investment) known as the “hurdle rate” is met.
This interest can be about 20% of the returns and is a certainly handsome sum on billion dollar deals. This is also often referred to as the Performance Bonus/Fees and typically shared among the senior level professionals.
New PE associates with a high rate of attrition usually don’t get a portion of the sum. Since returns are seen in some years, associates shuffle or move out in that period.
However, this policy differs between PE firms.
Dividend recapitalization (via Leveraged Buyouts)
Here, as mentioned before, a PE firm can take in additional debt to increase funds, keeping the target company as a collateral.
Sometimes referred to as PE firms paying themselves, this often allows them to take debt against healthy companies that offer relatively low risk leverage against debt.
In turn, the firms and the investors are able to cash out early (by distributing a special dividend) instead of waiting a few years to see returns.
Who do PE Firms hire?
It is a difficult and long sought dream for most. Almost no firm hires any undergraduate as they deal with heavy set clients who don’t have the time to wait till undergraduates get trained. Even graduate degree holders need an ample amount of investment banking experience with training in financial modeling.
They prefer those who have had roles in big bulge bracket banks, accounting experience at the Big 4 companies, or strategic management experience at BCG. Still they prefer MBA degrees from reputed schools, especially for their senior roles.
If you want to get into details on how to move into PE from undergraduate, graduate, engineering, or consulting, you can refer to this earlier article on How to get into Private Equity?
Also read Private Equity or Venture Capital jobs after MBA
Private Equity Tasks
New hires typically start out as Junior Analysts or Associates who are not directly involved in deal making process. They are usually aligned with data analysis, research, financial modeling, etc. that provide information for investments made by the senior professionals. In top firms like Blackstone, such analysts make about $200,000 annually.
The next level in the promotion rung are the Senior Analysts who act more independently than the junior ones. They perform more involved and responsible roles in a deal’s life cycle.
Towards senior job roles like Vice President, Director and Partner, the job descriptions shift to less of data handling and more into client relations, fund acquisition, negotiations, and other decision-making responsibilities. Partners are also required to invest their own wealth to own a portion of their partnership.
Top PE Firms and salaries
The salaries at senior PE positions are often hard to estimate on an average since they involve fractions of carried interests and dividend recapitalizations from buyouts. Therefore, it is easier to list out analyst salaries that typically don’t involve those hefty bonuses from profits.
Here are some of the top PE firms with their total assets under management (that is funds handled for investments) and average salaries.
Keep in mind that the salaries at PE firms depend on location. The same firm, located in USA, may pay significantly higher than its division in Europe or Asia. The tax laws on carried interests also determine compensation distribution. For instance, carried interests are taxed at a much lower rate than fixed income to encourage investments by LPs.
| PE Firm | Assets under Management (USD) | Analyst Salary Average (USD) | Director Salary (USD) |
|---|---|---|---|
| KKR & Co. Inc. | $491 billion | $103,000 | $290,000 |
| Blackstone Inc. | $941 billion | $102,000 | $309,000 |
| EQT Partners AB | $7.5 billion | $82,000 | $330,000 |
| CVC Capital Partners SA | $131 billion | $110,000 | $250,000 |
| Thoma Bravo LLC | $122 billion | $100,000 | $365,000 |
| Carlyle Group Inc. | $376 billion | $102,000 | $293,000 |
| General Atlantic Service Co. LP | $64 billion | $101,000 | $366,000 |
| Advent International | $31 billion | $95,000 | $395,000 |
| EnCap Investments | $18 billion | $125,000 | $366,000 |
| Neuberger Berman | $271 billion | $103,000 | $300,000 |
Sources: US News, Glassdoor
Not much data is available for other top PE firms like Clearlake Capital Group, Hellman and Friedman, Insight Partners, CVC Capital Partners, TPG Capital, and Warburg Pincus.
Clearly, this collated data is only as complete as reported. However, these are enough to gauge an estimate of how much one would be expected to make.
Given that it is a highly competitive sector, it is also a fact that once you are able to make it into a PE firm as a beginner analyst, climbing up the promotion ladder is a matter of learning on the job and executing your knowledge within the PE culture.
The hires are already well experienced investment bankers, strategy consultants or adept accountants with a lot of richness in their resume. Building on that expertise doesn’t take long.
So why does private equity pay so much?
Private equity is a highly competitive field. For one, it is very uncommon for undergraduates to make it in even with experience, let alone fresh graduates.
Top firms have a collective workforce of less than 20,000 associates across the globe and this exclusive club, if at all seeking new blood, only does so from top business programs or hire talented individuals who have what they need.
And what they need are a set of exclusive skills that capture the PE culture – one that is not just into investment but rather into looking at the best deals and building company profiles over a long period of time.
Second, they need recruits who are extremely well versed with the concepts of finance and strategy. Financial modeling is a must and in combination with analytical and critical thinking, PE firms expect a great deal of involvement into company operations.
Understanding companies, including the ability to grasp any domain knowledge to advise improvements, is a crucial aspect of building company portfolios. Just as, if not more significant, than fundraising.
Thirdly, PE firms deal in mature companies. Their transactions are in millions. Taking a company IPO can be rewarding, which makes sense given the growth of PE companies in the past decades. But, a misstep can also cost millions. Such a risky business mandates that the PE workforce are responsible for what is at stake.
And finally, quality breeds quality. A competitive PE firm that has a history of success in takeovers and deals will bring more investors and thus more opportunity to invest and fund companies. A cycle that is only guaranteed if the talent comprising the firm is capable, incredibly clever, and loyal.
Ultimately, private equity is an exclusive club that takes handsome care of itself and always seeks out only the best. And compensation is a big draw and reward for the same.
If you are interested to make it into this billion-dollar business, here are some links that may set on your track.
– Guide to Private Equity careers
– Best MBA programs for Private Equity and Venture Capital
– Private Equity vs Venture Capital vs Hedge Funds: Career choice
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