CJH2015 wrote:
Hi everyone,
Long-time lurker, hopefully can clear up the distinction a bit. Started as an analyst at a BB firm, pre-MBA associate @ PE, currently at H/S/W.
Investment banking is fundamentally a *sell-side* business. That is, they provide a service to corporations/sponsors (e.g. PE firms) etc. This includes M&A advice, equity/debt underwriting, research, sales and trading execution etc etc.
Private equity is exactly that. Private ownership in companies engineered typically through "leveraged" buyouts. It is what we call the "buy-side". Theoretically, the PE sponsor buys out the company, implements "structural" changes, and attempts to flip the company after a 3-5 yr timeframe in order to sell it for a profit. The operative word in that previous statement was "theoretically". In reality, nowadays what you see happening is PE firms buying out a company, doing a dividend recap while further leveraging up that company, firing workers, and then trying to sell the thing off to make a profit.
Alright now in terms of career, which one do you want to do? I just want to make one thing clear. A *lot* of people fetishize over PE, especially those who don't really understand what it is they do. Having done both Banking and PE, I can honestly say that I *prefer* banking. Why?
1) Compensation: The handful of megafunds typically do pay a bit more than the compensation to an IBD associate/VP etc. BUT, that implicitly factors in *carried interest*. Carried interest is essentially a co-investment at your PE firms fund. The problem with carried interest is that it may be worth a decent amount, ***or it can be worth nothing*** (see JC Flowers). In terms of cash compensation, the majority of middle-market PE firms pay essentially equivalent to what a BB-associate would make. So from a income perspective, neither IBD or PE will make you as rich as an entrepreneur, and in practical terms, progressing well in either will make you never want for anything.
2) Career Progression: Here's the main impetus behind my reasoning of why banking may be beneficial. IBD is a *sell-side* business. As long as you are essentially a good "sales-man", you are in a way your own little business within your bank. You can bring your rolodex with you anywhere, and be compensated for it. Additionally, there's no impediment to career progression. If you can get clients, you get promoted.
On the other hand, in PE, the key is since it is a *BUY-SIDE INVESTMENT BUSINESS*, no matter how "good" you are, you're not making the bulk of the money unless you put up substantial investment in the fund itself. I.e. You *must* risk your own capital in order to garner outsized returns. There is no reason for a PE fund to promote someone to "partner" *unless* they hold key relationships. The "technical" skills are the commodity - they can buy those off the labor market. The exception of course, is if you start your own PE fund... which again, comes down to pre-existing relationships.
3) Lifestyle: This is the only one where PE is a clear winner. Because you're on the buyside, you're not subject to the whims of the client (as you are on the sell-side). However, I want to add a caveat here. When you're on the sell-side, it's a fast-paced business where you need to make sure everything looks sharp in order to preserve your reputation and win clients. On the buy-side, you need to make sure everything looks sharp because you're risking $$$$$$$$ that belongs to your clients and your firm. The sell-side is more work, and in a sense, its very time consuming. But if you mess up a presentation, no one is losing hundreds of millions of dollars per se. On the buy-side, good luck if you get some numbers wrong.
Anyway, hope that serves a guide to non-finance MBA'ers out there. My hope is that everyone has a clear understanding of what PE is before automatically vying for it. Also one last note... with PE firms going public, expect returns to diminish and competition between firms to go up. Promotions to partner will be increasingly difficult as well.
Nice summary, CJH. Kudos to you my friend. If I could write a Cliff's Notes of your PE/IBD description, I'd say that IBD is for salesmen with a limited appetite for risk. PE is for those confident enough in their valuation and transaction execution skills to risk their personal capital. And for the most part, I agree with everything you said.
However, folks interested in IBD/PE going forward will want to pay close attention to comp structure for bankers. Bankers are receiving less cash up front and more compensation in the way of equity grants which do not vest for up to three years. If you are a banker who receives half of his comp in equity grants, the total value of your compensation is now directly aligned with the success of your bank. In a sense, the banker is now in the same position as the PE guy. If the bank (fund) does exceptionally well, he can become fabulously wealthy. If his bank (fund) tanks, he'll be outside the subway with an empty cup asking for spare change. Therefore, the distinction that PE is for more risk-inclined individuals and IBD is for those who are more risk-averse may not be as accurate in the future.
...Thoughts from a former middle market investment banker.
16 Jul 2010, 06:54
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