The Holy Trio of High Finance Part 1 - Private Equity

Hedge Fund, Private Equity and Venture Capital are what I call the “Holy Trios of Finance” because they are long-term destinations for finance people. I get enough questions about moving across these there paths that I should try my best to describe the three paths in details. I will cover areas such as entry point, day-to-day on the job, career progression path and compensation, the pros and cons.

The Holy Trios are investing roles, despite not having the word investing in their names. Their primary task is to make more money using clients’ money. With great responsibility comes great power – they are the first-class citizen in the finance world with the highest compensation upside and are served by the professions you salivate for – namely, Investment Banking (IB), Management Consulting, Equity Research (ER), etc. (For my non-finance audience, The Holy Trios are also called the “buy-side”. The professions that serve them are called “sell-side.”)

Conversely, with great power comes great responsibility - you need to know what you are doing. Comparing to making pitch decks in investment banking or writing earnings notes in sell-side research, your work for a hedge fund, private equity or venture capital can mean millions or even billions of client money being put to work.

The Holy Trio does not usually hire straight out of college, because they can source talents from the sell-side where the foundational skills are taught. There are exceptions, but most of us are not that wunderkind from Yale who got into Blackstone straight out of undergraduate.

So keep reading, or WATCH this article below:

What Is Private Equity

Private equity firms invest in private businesses or turn public businesses private.

Most PE firms engage primarily in leveraged buy-out (LBO), a fancy technical term that describes buying a whole business using mostly debt. The idea is very simple, it works the same way as buying a house or a car with loan. Over time, your ownership, or equity, in the car or house increases as you pay off the loan. Same works for leveraged buy-out, but of course owning a business is more complicated.

PE investors are truly long-term (not your typical “private equity approach to the public market” type hedge funds with a 500% annual portfolio turnover-type): They have a 3-7 year holding period.

They focus on operational improvement to make sure there is enough cash flow to service the heavy debt load. Diligence is very deep because you have all the information that is not available to the public investors and you can decide how to run the business. However, you cannot change how the external competition and macro environment impact the business. So it’s still far from a sure thing in making money.

Entry points

  • Investment Banking: the typical feeder profession for PE
  • Direct from undergraduate: really reserved for a very limited number of top undergraduate schools – I presume Ivy League
  • Management Consulting: Without transaction experience gained from doing IB, the risk is you could be pigeonholed into an operation role at a portfolio company instead of the traditional PE associate path.
  • NOT MBA: It’s nearly impossible to break into a traditional private equity role without IB experience. Even if you pursue an MBA, you will need to work as an IB associate before getting looks from PE firms.

Day-to-day

  • Modeling (LBO)
  • Research / diligence (management, industry, experts, etc.)
  • Write investment memos, prepare materials for investment committee
  • Support portfolio companies
    • FP&A, board meetings, management meetings, day-to-day business operation, follow-on financing needs
  • Hours are 65 hours on average. Can converge to IB hour during live deals. Still overall better than IB, but if you compare to insanity, anything is better.

Org structure

  • Associates: They are the doers - modeling, PowerPoint and writing (thought you are done with that after IB)
  • VP: They transition from doer to a project manager. Managing the deal by leading conference calls with the company, consultants, lawyers and any other parties involved in the deal process to make progress.
  • Director / Principal: They are more removed from the deal process and more involved in deal sourcing.
  • Partner: They are relationship folks who have paid their dues. They are mostly sourcing private companies to buy by talking to owners. They also represent the PE firm in fundraising and industry conferences. Textbook example on steroid at this ranking would be David Rubinstein of Carlyle.
  • Operating partners: They usually have C-suite or management consulting experience. I am not going into details but they are deployed to portfolio companies to drive change and value (cutting cost will be one way of course, we all know that)

Compensation

  • Very structured and stable, but it varies across fund sizes. So I will exaggerate by using mega PE firms (the likes of Blackstone, KKR and Carlyle) as example. Based on the 2022 Heidrick & Struggles survey:
    • Average Base + Bonus on 2021
      • Associate: ~$350,000
      • VP: ~$750,000
      • Principal: ~$1,000,000
      • Partner: ~$2,000,000
  • That’s not even where the real action is at. In private equity, a big variable compensation piece is the carried interest, which is a share-in of the performance fee when a private equity fund achieves its promised return hurdle.
    • VP and above ranks start getting carries. Of course, the carry % increases as you move up the ranks. It’s probably very volatile. Again citing the 2022 Heidrick & Struggles survey: A VP, Principal, and a partner can get millions or even tens of millions in a year (in this case, average of $6,500,000, $16,000,000 and $50,000,000 for VP, Principal and Partner, respectively), completely dwarfing what they make on base and bonus
    • Venture capital compensation works very similar way, as we will see in my next article

Good and bad

  • Good: Deep research; Long-termism; Learn about operations; Good exit opportunities because of the combination of financial and operational skills. 
  • Bad:
    • Still very long hour
    • Takes time to progress to senior level
    • No matter what subgenre of PE, you will be looking at slow and steady but unsexy businesses

Grass is Greener

Some PE professionals want to work in a hedge fund because:

  • Pure focus on identifying investment ideas without dealing with the process work
  • Better hour
  • Compensation upside is higher and quicker career progression

The trade-off:

  • Hedge Fund is much less stable. You can make $0 bonus in a year, or worse, very topical right now – hedge funds are shutting down left and right, depends on the strategy.
  • You are never off: Hour is better, but no one becomes a better investor by just working 60 hours a week. You will never be off at a hedge fund. Hedge fund is just long hour but condensed, driving burnout in a similar fashion just like how long hour drives burnout at PE.
  • Secularly declining: A critical vector in compensation upside is the growth in AUM. It’s a rhetorical question: when is the last time you heard a hedge fund raise billions? Hedge fund and the broader public investment management industry are secularly challenged. As an investor, I like to invest in where the tailwind is – hedge fund’s glorious 2/20 days are long behind us.

I will talk to you next week on venture capital

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