Finance and Private Equity: A Comprehensive Guide

Finance and private equity are often misunderstood, but at its core, private equity is a type of investment where a company or individual provides capital to a private business, with the goal of eventually selling the business for a profit.

Private equity firms use this capital to help businesses grow and become more profitable, often by making strategic investments and improvements.

Private equity firms typically look for businesses with strong growth potential and a solid financial foundation.

These firms may also provide operational support and guidance to help businesses achieve their goals.

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Private equity firms raise capital from outside investors, called Limited Partners (LP), and use it to buy companies, operate and improve them, and then sell them to realize a return on their investment. This process is called "private" equity because the companies they invest in are private initially, or become private as a result of the investment.

Private equity firms tend to acquire entire companies using equity and debt, which is different from hedge funds that acquire very small stakes in companies or other liquid financial assets. They hold these companies for the long term, typically 3-7 years, to allow for business growth and operational improvements.

The industry is made up of outside investors or Limited Partners, such as pension funds, endowments, insurance firms, family offices, funds of funds, sovereign wealth funds, and high-net-worth individuals. These investors provide the capital for private equity firms to make investments.

Private equity firms often require their Limited Partners to lock up their money for years due to the long-term nature of their investments. This can be a challenge for some investors who need access to their funds quickly.

Here are some key characteristics of private equity firms:

Private equity firms can be categorized in various ways, but one way is to look at the stage of investment. For example, some firms focus on very early-stage companies with high failure rates, while others invest in more mature companies looking to scale up their operations or penetrate new markets.

Private equity firms can also be classified by their target geography, with some focusing on the U.S., North America, Europe, Asia, or emerging markets. This can affect the types of companies they invest in and the strategies they use.

In terms of fund strategy, private equity firms can be divided into several types, including Venture Capital (VC) Funds, Growth Equity Funds, Leveraged Buyout (LBO) Funds, Distressed/Turnaround Funds, Mezzanine Funds, Real Estate Funds, Infrastructure Funds, and Fund of Funds.

Some private equity firms have expanded into different strategies over the years or started new spin-off firms that make different types of investments. This can make it challenging to categorize them neatly into one bucket.

Here's a breakdown of some common types of private equity funds:

Private equity firms can also be classified as either Venture Capital or Buyout/Leveraged Buyout (LBO), with LBO funds investing in later-stage or mature companies and taking a controlling interest in the company.

Private equity investments often outperform other investment types due to their potential for high returns.

Returns on private equity investments can be significantly higher than those of stocks, with average annual returns ranging from 8-12%.

In contrast, bonds typically offer lower returns, usually around 2-5% per year.

However, private equity investments come with a higher level of risk, as they are often tied to the performance of a specific company.

Private equity firms typically invest in companies with high growth potential, which can lead to substantial returns but also increases the risk of losses.

For your interest: Risk Financing

Private equity firms acquire entire companies using equity and debt, and they often require their investors to lock up their money for years due to the long-term nature of their investments.

Private equity firms tend to focus on mature companies rather than startups, and they manage their portfolio companies to increase their worth or to extract value before exiting the investment years later. This approach is in contrast to venture capital, which invests in early-stage companies with high failure rates.

Private equity firms can be classified into different types based on their investment stage, target geography, fund's target sector, value added by the firm, and exit strategy. Some common types of private equity funds include Leveraged Buyout (LBO) funds, Growth Equity Funds, Distressed / Turnaround Funds, and Real Estate Funds.

Here are some key characteristics of private equity funds:

Private equity firms often have a finite term of 10 to 12 years, and the money invested in them isn't available for subsequent withdrawals.

The history of private equity investments is a fascinating story that spans over a century. In 1901, J.P. Morgan made one of the earliest and largest corporate buyouts by purchasing Carnegie Steel Corp. for $480 million and merging it with other companies to create U.S. Steel.

This marked the beginning of private equity investments as we know it today. J.P. Morgan's move was a bold one, and it paved the way for future private equity firms to buy and overhaul companies to earn a profit when they are sold again.

One notable example of a private equity firm's success is KKR's leveraged buyout of RJR Nabisco in 1989. This deal, worth $25 billion, is still the largest leveraged buyout in history when adjusted for inflation.

Private equity firms often use borrowed money to finance their acquisitions, as seen in Henry Ford's purchase of his partners' shares in 1919. This strategy can be effective, but it also carries risks, particularly if the company is saddled with unsustainable debt.

The private equity industry has grown rapidly over the years, and it tends to be most popular when stock prices are high and interest rates are low. This creates a favorable environment for private equity firms to raise capital and make acquisitions.

Interest Rates have a significant impact on Private Equity (PE) funds' ability to perform. High interest rates make borrowing capital more expensive and difficult to secure.

This can limit the amount of assets available to invest, making it challenging for PE funds to afford high potential allocations. They may also struggle to move quickly enough to make the most of investment opportunities.

If interest rates are high, PE funds may not be able to borrow enough capital to take on high-risk investments, which can limit their potential returns.

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Private equity funds are considered closed-ended funds, meaning they only raise capital for a specific period of time from a limited number of investors. This average time between the start of the capital raise and the close currently sits at 15.4 months.

The minimum investment required for a private equity fund can be substantial, with an average of $25 million historically required. However, some funds have offered access for as little as $25,000 in recent years.

Private equity funds typically invest in mature companies, rather than startups, and manage their portfolio companies to increase their worth or extract value before exiting the investment years later. This is in contrast to venture capital, which invests in very early-stage companies.

The private equity industry has grown rapidly, with private equity buyouts totaling $654 billion in 2022, the second-best performance in history. The industry tends to be most popular when stock prices are high and interest rates low.

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Private equity firms can be classified into different types, including venture capital, growth equity, leveraged buyout, distressed, mezzanine, real estate, and infrastructure funds. Each type of fund has its own unique investment strategy and focus.

To invest in a private equity fund, you typically need to be an accredited investor, meeting at least one of the following criteria: individual income of $200,000 in each of the previous two years, joint income with a spouse or partner of $300,000, net worth of $1 million or more, or other specified qualifications.

Here are some key differences between private equity and hedge funds:

Private equity firms typically hold their portfolio companies for 3-7 years, with an average holding period of 5.6 years in 2023. The funds do typically start to distribute profits to their investors after a number of years.

Private equity firms raise money from institutional investors and individual investors, just like you and your friends raising money to flip houses.

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They use this money to invest in companies, taking on a more active role than traditional investors.

The process involves fundraising, operational management, and investing, with the goal of generating profits for investors.

Private equity firms typically keep some of the profits for themselves, but return the majority to their investors for providing the bulk of the required capital.

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Imagine you and your friends buying homes, fixing them up, and selling them at higher prices. That's basically what private equity firms do, but on a much larger scale and for companies rather than houses.

Private equity firms raise money from institutional investors instead of friends and family. They use this money to acquire companies, make operational improvements, and increase the investment's worth.

A private equity firm's job is part fundraising, part operational management, and part investing. They have a limited time to add value before exiting an investment, which gives them a strong incentive to make major changes.

Private equity owners may bring in their own management team to pursue initiatives like developing an e-commerce strategy or adopting new technology. This can help the acquired company make operational and financial changes without pressure from public shareholders.

Growth is a key area of focus for private equity firms. Growth equity funds invest in mature companies looking to expand.

These funds target scalable businesses poised for growth, often with a focus on entering a new space or emerging market. Growth equity funds typically only take a minority stake in the company.

Their goal is to help the business grow and eventually exit at a higher multiple. This means they're looking for companies with strong potential for expansion and increased value.

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Private equity firms acquire companies with a plan to increase their value, often by making dramatic cost cuts or restructuring. This can be difficult for a company's incumbent management to do, but private equity owners have a limited time to add value before exiting, giving them a strong incentive to make major changes.

Private equity firms often bring in their own management team to execute an agreed-upon plan, or retain prior managers to do the same. This allows the company to make operational and financial changes without the pressure of meeting analysts' earnings estimates or pleasing public shareholders every quarter.

Industry surveys suggest that operational improvements have become private equity managers' main focus and source of added value. By streamlining operations and improving efficiency, private equity firms can increase a company's profitability and make it more attractive to potential buyers.

Debt remains an important contributor to private equity returns, even if leverage is less essential due to the increase in fundraising. Private equity managers can use debt to finance an acquisition, reducing the size of the equity commitment and increasing the potential return on investment.

Private equity managers can also cause the acquired company to take on more debt to accelerate their returns through a dividend recapitalization. This allows the private equity owners to extract value quickly, but saddles the portfolio company with extra debt that can be difficult to manage.

Mastering LBO modeling and PE cases is essential for private equity professionals, and involves learning key skills such as creating short models and analyzing real-life case studies. By mastering these skills, individuals can prepare for PE interviews and demonstrate their understanding of the private equity process.

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Private equity funds are managed by a general partner, also known as the private equity firm that established the fund. This general partner makes all the management decisions and contributes a percentage of the fund's capital to have skin in the game.

The general partner typically contributes 1% to 3% of the fund's capital. This is a significant investment, as it shows the general partner is committed to the fund's success.

The general partner earns a management fee, which is often set at 2% of the fund's assets. This fee is a standard practice in the private equity industry.

In addition to the management fee, the general partner may be entitled to 20% of the fund's profits above a preset minimum as incentive compensation. This is known as carried interest, and it's a key aspect of private equity fund management.

Private equity careers can be a great fit for those who enjoy investing and operations, but let's be real, most people are drawn to the high salaries and compensation, somewhat better hours than investment banking, and more interesting work.

Getting into private equity is extremely difficult, and once you're in, the job is stressful and requires long hours and sacrifices, especially when deals are in their final stages.

To advance quickly in private equity, you'll need to perform well and be willing to put in the hard work, with a typical career progression taking around 2-3 years to move from Analyst to Vice President.

Here's a rough idea of what to expect in terms of total compensation (base salary + annual bonus + carry) at different levels:

It's worth noting that the most common entry-level roles in private equity are Analysts and Associates, and getting into private equity directly after an MBA is nearly impossible unless you've done investment banking or private equity before the MBA.

Working in private equity can be a great career choice for those who enjoy investing and operations, and want to build value for companies over the long term.

High salaries and compensation are a major draw for many people, offering a financial reward that's somewhat better than what's typically found in investment banking.

Private equity work can also be more interesting, with the excitement of working on large deals and interacting with top talent.

Unlike investment banking, private equity itself is viewed as an exit opportunity, so you don't have to worry about finding another job when you're done with your PE experience.

Better hours than investment banking are another perk, giving you more time to enjoy your personal life outside of work.

If you're considering a career in private equity, it's essential to know the top firms in the industry.

Kohlberg Kravis Roberts (KKR), one of the world's largest private equity firms, has over $600 billion in assets under management.

Blackstone Group, another prominent player, manages over $500 billion in assets.

The largest private equity firms have a significant impact on the industry, with many smaller firms looking up to them for guidance and investment opportunities.

Kohlberg Kravis Roberts (KKR) has been around since 1976, giving it a significant head start over newer firms.

Breaking into private equity is notoriously difficult, but if you manage to get in, you can expect a challenging job with long hours and sacrifices, especially during deal-making periods.

The typical career progression at a mid-sized-to-large private equity firm in New York City involves a series of promotions that can lead to high salaries, bonuses, and a share of the profit from investment returns.

Here's a breakdown of the typical positions, ages, and compensation ranges:

As you can see, the compensation ranges are significant, but they come with a price: long hours, sacrifices, and a high level of stress, especially during deal-making periods.

The most common entry-level jobs in private equity are Analysts and Associates. Analysts are hired directly out of undergraduate and assist Associates with tasks such as financial modeling and deal analysis.

Associates, on the other hand, usually join after working as Investment Banking Analysts at bulge-bracket or elite-boutique banks. They tend to focus more on driving deals to completion rather than assisting with tasks of the day.

At smaller firms, more Associates come from middle-market and even boutique banks. Some management consultants and Big 4 and corporate development professionals also get in.

Here are the two most common entry-level roles in private equity:

To succeed in private equity, you need to be technically proficient and demonstrate a strong "fit" with the firm. Private equity firms are much smaller than investment banks, with each team member having more responsibility.

Investment banking interview guides can help you prepare for private equity interviews. For example, the Investment Banking Interview Guide from Mergers & Inquisitions includes a 120-page guide to LBO modeling and 4 practice LBO case studies/modeling tests.

Private equity firms want professionals who can add value from day one, which is why many aspiring professionals invest in specialized courses and training. Some courses, like BIWS Premium, include more in-depth LBO case studies and foundational financial modeling skills.

To master LBO modeling, you can take courses like Private Equity Modeling (LBO Modeling) from Mergers & Inquisitions. This course includes 6 conceptual models and 6 full, step-by-step case studies.

If you're interested in roles investing in earlier-stage companies, you may want to consider courses like Venture Capital & Growth Equity Modeling. This course covers knowledge of cap tables and granular financial models, which are essential for these types of roles.

Here are some courses that can help you succeed in private equity:

These courses can help you win interviews and job offers for roles that pay $150K+ and position you for careers in private equity.

Entities can qualify as accredited investors to invest in a private equity firm, just like individuals. This can include corporations, partnerships, and LLCs.

To qualify, entities must own investments totaling more than $5 million. Alternatively, they can own assets valued at more than $5 million in total.

Entities may also qualify if they are owned by an accredited investor, or if they are registered as an investment advisor or broker-dealer. Financial institutions like banks, insurance companies, and RIAs can also qualify.

Here are the specific conditions for entities to qualify as accredited investors:

Getting paid in private equity can be a lucrative career move. Private equity firms raise capital from outside investors, called Limited Partners, and use this capital to buy companies, operate and improve them, and then sell them to realize a return on their investment.

If you're considering a career in private equity, you'll likely be working long hours and making sacrifices, especially when deals are in their final stages. But if you perform well, you can advance quickly and earn high salaries, bonuses, and carry.

Here's a rough idea of what a "typical" career progression might look like at a mid-sized-to-large private equity firm based in New York City:

Fund sponsors in private equity typically get paid through a small "management fee" that covers the cost of operating the fund and a "performance fee" that gives the fund a share of the fund's profits. This fee structure is often referred to as "2 and 20" – meaning a 2% management fee and a 20% performance fee.