By Anthony Parrish
Do you ever think about your prospect pool by industry, segmenting groups into big buckets like tech or finance? Whenever I do, I’m a little overwhelmed by the sheer variety of careers in a single industry. Sometimes, I find it helpful to take one smaller subset and look at it more closely. Take, for example, private equity.
What do I, as a prospect researcher, know about prospects in private equity? Is it just the unbelievably large share of the Forbes 400 that come from the industry? Is it The New York Times’ DealBook article from 2016 that noted the nine-figure compensation packages of the top private equity executives, outpacing even banking CEOs? Maybe it’s the surprise in an article from this past April in the Institution Investor revealing that private equity professionals’ compensation remained virtually unscathed by the pandemic? Or perhaps the double digit pay gap based on gender, as seen in the most recent private equity compensation report from Heidrick & Struggles?
Well, before we go down a bunch of rabbit holes, let’s start with the basics. What is private equity and why should I care if my prospects work in that industry?
The simplest definition of private equity is that it is an alternative way to invest money outside of the public markets; private equity firms take money and directly invest it in companies with the goal of getting a positive return on investment. Another way to think of it is that investors (as companies or individuals), which can be outside (limited partners) or inside (general partners) the private equity firm, provide cash for the private equity fund to invest in various portfolio companies, and the private equity firm’s fund managers steer that investment.
Sometimes private equity firms just invest in companies with the expectation that the existing management will grow the company and the firm will get a strong return on investment. Other times they actively step in with operational oversight/support and/or require board seats in return for their investment; there can be a real variety within the industry.
In terms of the firms making money, there are three general ways they create revenue: 1) management fees, 2) carried interest/performance fees, and 3) dividend recapitalizations.
- Management fees are the simplest form of revenue: investors (limited partners) are charged around 2% of the capital invested regardless of the outcome of the investments (the rates can vary a little if a fund is winding down, but 2% is pretty standard).
- Carried interest and performance fees are directly tied to the investment performance and help align the limited partners’ and the private equity firm’s interests. Performance fees can vary in size (a common number you’ll see bandied about is 20%) and are only paid out to a firm once the investments hit a certain rate of return (typically 8%). We’ll touch on these more in Part 2.
- Dividend recapitalization is not as common and works as an advance to investors (both LPs and GPs) on a company’s eventual sale: the private equity firm uses a portfolio company to take on new debt and then distributes a special dividend to investors. This last form of revenue is sometimes noted in news articles as a private equity firm paying itself, but it is also the only way for shareholders of a portfolio company to receive a return without an exit (through an initial public offering or private acquisition).
One thing to note, is that the type of private equity firm may impact which of these is the primary source of revenue. Larger private firms and larger publicly traded firms (think Apollo), rely more on management fees, while smaller firms rely more on performance-based revenue.
If you really want to dig into it a bit more, I found the following overviews helpful:
- Investopedia’s What is Private Equity? and Understanding Private Equity
- The U.S. Securities and Exchange Commission’s Investment Products: Private Equity Funds
- PitchBook’s What is Private Equity and How Does It Work? and How Private Equity Firms Make Money
Great, thanks for the overview, but what is going to help me with my prospects?
I’m glad you asked! Let’s dig into what a career in private equity looks like. When you start out in the field, you typically have an associate/analyst title. While this might not seem grandiose, the compensation can be to the tune of $400K annually at the top end of the field, as Fortune recently pointed out. (Not everyone will start there — the industry average is closer to a low six-figure number.)
Moving through the ranks as a private equity professional, you’ll eventually become a vice president, or maybe a principal. These roles are a little trickier to estimate because the compensation range is larger, from $200K up to $500K-plus. But this pales when compared to the potential compensation at the partner/managing director and managing partner stratosphere. Here, annual compensation can balloon into seven, eight and even nine figures. At this level, the range is so large, that it can be helpful to look for more details around compensation.
Please tell me there are better sources than a general web search for this information…
There are a lot of sources to look at when it comes to compensation, but sometimes Salary.com and Glassdoor.com don’t seem to give you a complete picture. That is when I turn to salary surveys.
Some for private equity include Preqin’s Private Capital Compensation and Employment Review (available for $4,550), MM&K’s PE & VC Compensation Report (no price listed, but not free), and the free one we’ll use for this example: Heidrick & Struggles’ Private Equity Investment Professional Compensation Survey (free to download).
If you’re wondering about the differences among these sources:
- Preqin’s has global coverage and comes from a firm that provides financial data to firms in the industry.
- MM&K’s has European and North American coverage and comes from a compensation advisory.
- Heidrick & Struggles only covers North America and comes from an executive search/leadership consultancy.
- There are other providers of industry compensation benchmarks, some of which can be very geographically or portfolio company industry focused.
There is a lot to unpack from these reports, and I encourage you to dig into them when you’re looking at a particular prospect. But be sure to remember this one important caveat: assets under management (AUM) matters, all the way from the managing partners down to the first-year associates.
A larger AUM usually translates to higher compensation levels across the board. If you know that one of your prospects is at a top private equity firm, you can expect compensation to be on the higher end of any range you find. Conversely, just because someone started a private equity firm, it doesn’t mean much if they aren’t managing any assets.
Even with all this information available, sometimes you just don’t get the numbers as precise as you’d like. And luckily, there are some solutions for partners/managing directors/managing partners in estimating their compensation…
Next time on Meeting Your Prospects in Private Equity:
- 2 and 20: The simple formula for estimating private equity partner compensation
- Form ADV: A pain to read, a wealth of information
- Return rates: Putting a number on performance
- Caveats and why estimates are oh-so-important