what's up everyone kenji here and in this video i thought i'd give an overview of the
private equity industry so firstly we'll start off with what is private equity
then we'll look at some of the ways that they make money then thirdly we'll go over the investing
strategies that they have and then lastly we'll go over the career paths in private equity
looking at things like the work hours the skills required and the compensation let's go so what is
private equity and in short private equity funds raise money from outside investors and with the
money they acquire companies and then they look to take a hands-on approach to improve their business
and then hopefully in five to ten years time they'll be able to resell it for a profit now
the reason it's called private equity is because these funds invest in private companies sometimes
they do invest in public companies but the goal is to take them back to private now if you don't
know the difference between a private company and a public company a public one is one that trades
in the financial market so that means that anybody can buy it say i can go to my broker and buy apple
shares for instance because it's a public company on the other hand the private one is usually
just owned by the founders the management team and maybe a couple early investors so it's not open to
the public taking a macro view when looking at the different asset classes private equity falls
into the alternative investments category such the same bucket as hedge funds real estate and so on
so this isn't really an area that normal people invest their money in instead it's usually just
industry professionals so some of the big investors usually include pension funds
sovereign funds endowments as well as high net worth individuals in terms of risk levels private
equity is regarded as quite risky and that's also why investors expect a high return for that
now the reason is risky is because when you're trying to transform a whole business so there's
many variables to it it might not work out and so on and at the same time it's regarded as an
illiquid investment so liquidity is basically a measure of how easily something can be converted
into cash now a liquid is at the bad end of the scale say so it takes a long time to convert
and among other eliquid assets are real estate for instance where there's a lot of paperwork
a lot of contracts required for you or anyone to be able to sell their real estate while on
the other hand on the very liquid side there's something like shares of apple apple stock for
instance where everyone is buying and selling so it's very easy for you to convert into cash
so private equity is seen as an illiquid investment mainly because you're investing
in projects that last five to ten years and you can't cash out before that now you may be
aware that private equity sometimes gets a bad reputation so let's look into why that is and
there's primarily two main reasons firstly it has to do with the actual transformation or maximizing
a business right and that often involves cutting costs and among the biggest costs out there
are salaries so employees in this case so that means that they have to lay off a lot of employees
often and that's something that gives them a bad reputation at the same time there's another reason
and it's that they're usually in there for five to ten years trying to maximize their returns so
they're not really interested in whatever happens after five to ten years because they don't really
have any money to be made there right so that means that they can sometimes be overly aggressive
all right so how they make money and it's usually a combination of a management fee
and a performance fee and the industry standard is known as the two plus twenty the 2 stands for
the management fee so this is the fee for paying down the technology the office space employees and
so on and this one's fixed so that means that even if they lose money or they win money they're going
to get the same amount and then on the other hand there's the performance fee and this one's usually
unlocked once they hit a certain certain threshold so for instance once they sell the investment and
they make a profit on it then they can take it 20 percent off that as you can see it's quite aligned
in that both the investors as well as the fund is going to be happy if they get good returns overall
the bigger the fun the more exaggerated this two plus 20 structure becomes a two percent of a 10
million fund might not sound like that much but a two percent of a 10 billion fund obviously starts
to become quite a lot of money but overall depending on the reputation of the fund they
might actually have a bigger structure than a two plus twenty so maybe a three plus thirty
or a smaller one if they're not so reputable like it's a oneplus 15 right so within private
equity most funds specialize in certain investment strategies as you can imagine investing in a small
startup is not the same as investing in a company with 1000 employees right so let's look at some of
the main ones here's a table showing a breakdown of some of the most popular strategies out there
so first one has to do with venture capital and this is the smallest investment size it basically
has to do with investing in startups now they're looking to hit home runs so they're looking for
massive returns that might happen once every 10 investments for instance so something like 500
plus ownership here is minority so that means that they don't take control of the business and
examples of some of the big vcs include sequoia or anderson horowitz i did make a video just on
venture capital if you're interested in that i'll leave it linked somewhere up here secondly we have
growth equity and this one's sort of in between the venture capital space and the big leverage
buyout space so they're looking at companies that are a bit more established than startups
transaction amounts here are usually in the 25 to 100 million range and the home run is not really
a goal anymore but rather getting steady returns of around the 30 mark ownership here is a bit in
between the minority and the controlling position so they might have some influence on what they do
with the business as well some examples of growth private equity funds include general atlantic or
ta associates and lastly you have leverage buyouts which are also known as lbos and you
might have heard of this term being thrown around before this basically has to do with financing an
acquisition of a company through debt primarily so typically it's around 80 debt and only 20
equity now this is usually done in the context of taking a public company private so the amounts are
typically above the 100 million mark and the fund has full control of what they do with the company
now the reason it's so attractive for private equity funds to use this leveraged buyout method
is because they use very little equity and a huge amount in debt which translates to really high
returns because over say five to ten years the company is able to pay off the debt and with it
the equity returns just increase and so does the overall valuation as a company just keeps growing
now going back to the fee structure this is really how they maximize their performance fee
but it is obviously very risky what if the company is unable to pay down the debt they obviously have
a problem then so for lbo candidates for leveraged bio candidates they look for companies with very
stable cash flows that have a stable business model so it means that with that cash they'll
be able to be paying down the debt throughout time when it comes to companies with this kind
of a strategy the biggest ones are blackstone and kkr and there's obviously many other strategies
out there like distressed debt or real estate but i don't want to make this video too long
when it comes to careers and private equity the traditional approach is to work at an investment
or a management consultancy for around two to four years and then make the switch to private equity
now the reason say investment banking analysts are so keen to get into private equity
is for a couple reasons firstly the pay is usually better secondly the work hours are
usually slightly better and then thirdly has to do with the work itself which some people regard
as just more interesting because you think of companies more strategically i'd say having two
to four years of experience is the most common way to get there but there are an increasing number of
funds that have summer internships as well as first-year programs so for people fresh out of
college an example of that is blackstone when it comes to work hours it's usually around 60 to 70
hours a week which is slightly better than the 80 hours you might average at an investment bank
or the 70 hours you might average at a management consultancy when it comes to skills required your
bread and butter is going to be financial modeling so finance and accounting as well as excel are
obviously big points there and at the same time being good strategically so understanding a
business model and how to optimize it and then lastly being able to communicate well as you'll
probably be talking with the management team of a company and you want to come across politely
salary wise you can expect to earn around 130 000 in base salary in a big u.s city like new york say
but the big portion here is actually the bonus which can double or even more than that so you
can expect to earn say around 300 000 depending on your performance as well as that of your team
now these figures are for the top funds out there but you also got to keep in mind that they do have
around two to four years of experience typically so that means that they're not so junior anymore
lastly if you want to learn further about the topic here's a couple things i recommend firstly
it's got to do with this book called king of capital i thought it was really insightful
on the private equity industry all the way back from the 1980s to what it's like today
with a special focus on blackstone which is the biggest fun out there but if you're feeling a
bit more lazy there is also a movie which is called barbarians at the gate and it focuses on
the biggest leverage buyout back in the day which was that of rjr nabisco and it is based on a real
story where henry cravis was involved who's one of the co-founders of kkr which is still going strong
today with around 250 billion under management so that's all for this video i hope you enjoyed it if
you did feel free to like and subscribe really helps out i'll catch you guys in the next one