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To know if the buyside is right for you, let’s start with a textbook understanding of “What is private equity?” Private equity involves investing capital directly into private businesses that are not publicly traded on stock exchanges (that would be a hedge fund). As further discussed below, private equity firms raise funds from institutional investors and use these funds to acquire ownership stakes in businesses.
The main goal of private equity companies is to enhance the value of the companies in which they invest, usually over a 5 to 10-year hold period, and then exit their investment.
During the hold period, the private equity firm can improve operations, management structure, and financial strategies to optimize the business. Once improved, the exit can then take place, usually in the form of another sale or an Initial Public Offering (IPO), both of which are usually under the advice of an investment bank.
Assessing if Private Equity is Right for You
Now that the private equity space has been defined, it’s time to understand if the buyside is right for you. Many first-year (and some second-year) analysts are unsure if private equity should be their next step. The good news is that there are many transferable skills from investment banking (and other non-traditional finance roles) to private equity. If you enjoy financial modeling and due diligence (essential skills for most finance roles) but want to dig deeper into how businesses function operationally, then the buyside could be right for you.
In private equity, you will see deals for a longer period than the typical 1-3 months as a transaction advisor. In investment banking, closing the transaction marks the end of the engagement. In private equity, closing the transaction marks the beginning of business plan execution.
This provides the opportunity for private equity analysts and associates to learn holistically how to restructure or grow a target company post-acquisition and then how to position the company for an eventual sale. Strategic thinking skills are essential.
Key Skills for Private Equity Success
The ability to develop and execute effective investment strategies (as well as adjust them depending on headwinds) is a cornerstone of private equity success. You must be able to consider long-term goals, assess risk, and craft plans to enhance the value of portfolio companies.
1. Due Diligence in Private Equity
Due diligence is arguably more important on the buyside than in any other finance role, given that you have to live with your investment for the long term. As a result, be sure you enjoy the due diligence component of your current role (if there is one), given that it will be 10 times more pronounced on the private equity side. Thorough due diligence skills are essential for assessing the financial, legal, and operational components of potential investments a private equity firm undertakes. Attention to detail and in-depth research will reveal potential risks and opportunities. There is very little margin for error, especially since any error can be very costly to the overall deal. People have lost their jobs over mistakes made during the acquisition process.
As with most finance roles, private equity transactions involve working closely with deal team members, other management teams, legal counsel, and other third-party advisors.
2. Collaborative Skills and "Fit"
Collaborative skills are crucial for effective teamwork and achieving common objectives, and given the long hours, “fit” is important as well. Private equity deal teams tend to be leaner, which puts even more importance on this “fit” component. But at the same time, it gives the opportunity for analysts and associates to work on the deal more intimately and with more autonomy than they make experience elsewhere.
3. Intrapreneurship in Private Equity
To further this, in investment banking and other corporate finance roles, processes are established to make junior-level roles more systematic and, (ergo) repetitive. A lot of investment banking tasks for junior team members, for example, involve moving things from Bucket A to Bucket B 100 times over and over. But in private equity, “Intrapreneurship” is key at every level. Junior team members opinions are heard more often, and they are encouraged to speak up, especially given the aforementioned leaner deal team.
4. Understanding Different Types of Private Equity Firms
It’s also important to understand two different types of private equity firms: LPs (Limited Partners) and GPs (General Partners). Limited partner private equity shops are generally firms that raise capital (funds) and deploy that capital in various investments headed by a GP. General partner private equity shops usually source the deal and then run the day-to-day operations, executing the business plan through the hold period of the investment.
Working at an LP shop, you will generally see deals that have already been vetted by a GP shop, which takes out a lot of the legwork to find a “good deal”. On the other hand, working at a GP shop, your firm will source the deal and put together all the pieces, including raising equity and coordinating debt (together known as the capital stack, or cap stack for short).
Note that GPs will often have “inch-wide and mile-deep” knowledge of a specific industry, while LPs may invest in a wider variety of sectors.
5. Compensation in Private Equity
It’s important to also understand how the LP private equity shops and GP private equity shops make money. LPs make money by charging a management fee on their funds (commonly 2%) and also a percentage of the promote (20% as a general rule of thumb).
This has led to the common private equity compensation phrase “2 and 20 fund structure“. General partners can make money off of a front-end acquisition fee and a back-end promotion, which is usually realized or received at the time of disposition.
Actual fund structures can vary. Generally, the compensation of analysts and associates at both LP and GP shops is similar, but as with most roles in finance, it can vary depending on the firm size.
In conclusion, the private equity industry may be a good fit for those who enjoy financial modeling and due diligence, have strategic thinking skills, and can work collaboratively with others.
Private equity deals involve inherently longer engagement periods and require more in-depth due diligence than most other finance roles. Attention to detail is crucial, as mistakes can be costly. Private equity firms can be either LP or GP in nature, and compensation for analysts and associates is generally similar.
Working at a GP shop involves sourcing deals and running day-to-day operations, while LP shops invest in deals that have already been vetted by GPs.
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