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Careers in Private Equity

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.
An LBO investor will normally take a control position, holding enough board positions to control a company’s major decisions. LBO transactions are normally valued on multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The debt used in the transaction will be raised from banks and the high yield bond market.

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

Key skill requirements for a job as a private equity associate include:

Industry / operating knowledge.
Ideally, you will have an intricate understanding of a specific industry and some operating experience in that industry. Many private equity firms strongly favor individuals who have significant operating experience along the way. The importance of operating and industry knowledge rises over time and can be critical to getting on the partner track and making it to the top.

Analytical skills.
You need basic abilities in developing and analyzing spreadsheets, particularly that rather complex “LBO model” that every firm works with. But much more importantly, you will need to appreciate the business model factors that are exposed in pro forma financial analysis. It is also very important to be able to parlay your financial insight into relevant questions about how a company is doing now in a market and how it could do with specific management initiatives. It will be important to be able to carry out quality research on markets, competition, customers, supply chains etc.

People skills.
Your ability to skillfully manage other people and eventually lead them is critical to your success in any private equity firm. The basics of communication, empathy and understanding are critical in getting teams to work and your work to flow. In addition, strong interpersonal skills will serve you well in the all important networking phase of finding a private equity position and of later attracting deal flow.

The Financial Crisis and Private Equity

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.

Key Career Opportunities

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.

Breaking into Private Equity

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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Compensation in Private Equity

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.

Key Work Activities in Private Equity Firms

Sourcing
Identify companies in which a fund could invest. Many private equity firms screen over a hundred candidates for every one invested in. Much of this will come through investment banks which provide new investment ideas summarized in memoranda.

Research
Development of industry and firm investment theses based upon research, talking to industry participants and attending trade shows.

Due Diligence
Once a qualified target is identified, a private equity firm conducts thorough due diligence process to ensure that the target company will meet the fund’s expectations in terms of growth, operations and ultimately, equity returns. Key areas of focus include the underlying business, management, financials and the competitive environment.

Execution
Getting the deal done – coordinating with the bankers, consultants, lawyers, and target company staff to drive the deal to an asset purchase and funding. This involves participating in auctions and doing what it takes to remove barriers to transaction completion.

Portfolio Management
Investments need to be actively managed through interaction with management and board positions. The level of involvement can vary substantially across investments.

Exit
Managing the process of recovering capital from an investment either through a public market sale (IPO or secondary) or an M&A transaction (sale to a strategic party or another financial buyer). Private equity firms try to exit investments within three to five years.

Related Career Areas

The PE 50, 2008

1 The Carlyle Group
2 Goldman Sachs Principal Investment
3 TPG
4 Kohlberg Kravis Roberts
5 CVC Capital Partners
6 Apollo Management
7 Bain Capital
8 Permira
9 Apax Partners
10 The Blackstone Group
11 Warburg Pincus
12 3i Group
13 Advent International
14 Terra Firma Capital Partners
15 American Capital
16 Providence Equity Partners
17 Silver Lake
18 Cerberus Capital Management
19 AIG Investments
20 Fortress Investment Group
21 General Atlantic
22 PAI Partners
23 First Reserve Corporation
24 EQT Partners
25 Hellman & Friedman
26 Cinven
27 Bridgepoint
28 Clayton, Dubilier & Rice
29 Teachers' Private Capital
30 Charterhouse Capital Partners
31 Lehman Brothers Private Equity
32 Thomas H. Lee Partners
33 BC Partners
34 AXA Private Equity
35 NGP Energy Capital Mgt
36 Oaktree Capital Management
37 Marfin Investment Group
38 Sun Capital Partners
39 Doughty Hanson & Co.
40 JC Flowers & Co.
41 TA Associates
42 Eurazeo
43 New Mountain Capital
44 MatlinPatterson
45 WL Ross & Co.
46 EnCap Investments
47 Madison Dearborn Partners
48 Barclays Private Equity
49 Onex
50 Welsh, Carson, Anderson & Stowe

Source: PEI

"It's not just buying the company. Sure, we picked the right companies, and we picked the right management and, most importantly, we've given them the right incentive to perform."

Henry Kravis

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