Why PE hires mainly IBs?
Background: had the possibility for short stints in both industries and I see more negative risk hiring only IBs instead of broadening the pool. I think the hiring trend just support the in my opinion negative trend of PE that will ultimately put PE companies at risk. With this I mean moving away from requiring money for good deals to just increasing fund sizes and live of mgmt fees. Where in the latter it probably makes sense to hire IBs because more funds, more deals, more mgmt. fees; however, is this sustainable given current challenges? First of all, I am happy to have my view challenged which is the main reason for the post. Why not only IBs? 1. from my working experience the IB side has often limited understanding of the industry, the operations of a company, market growth (with that I mean a better understanding than just the first 5 google searches that popped up) and most CIMs I have a read on both sides IB/PE are of very poor quality, really just poor marketing slides with little to no added value. Food for thought, please aggregate all EBITDA growth forecast and compare them to GDP assuming other factors above in the income statement stay similar (which they usually do), either they stupidly only sell the hidden champions of the industry or it’s just a marketing document that does not provide any accurate value except of the non-adjusted historical information and e.g. customer base information that can be put together by an admin worker. I also don’t want to tell about all the „comparable companies“ I have seen are not comparable at all but only cherry picked items from an overworked intern that supports what ever side they want to show.
Are they really smart or just hard working? Definitely they are very smart people in the finance domain, likely far more than the usual average. However, a lot are not. I do not want to attack anyone here but let us be honest, you do not need high intelligence and be a strategic, complex, lateral thinker to start out in this industry. You need good grades, grit for the industry and be smart enough to apply for internships in the right order early on. For the first point, having good grades in school or undergrad is really not challenging when you have a decent understanding of how to learn for different subjects. Also the „financial modeling“ is no rocket science.
More broad point about performance of teams in unkind environments (in my opinion PE is an unkind environment) where ample of research shows the significant outperformance of diverse teams with lateral thinking compared to a group of „experts“. One example are the works of Philip Tetlock. The above, in my opinion, would strongly support hiring a more diverse group of smart, diverse and lateral thinkers compared to the current „we hire only IBs“ with the same background.
I believe especially now, with more challenging environments it will become clear which funds will continue to perform and which will not. Investing in many domains the past 15 years was in most cases a no-brainer. Just look at stock performance, multiple expansions, cheap cost of capital, etc. Please attack or add to above points. I am not here to rant or convince people of my point but want to have a better understanding myself
Feels like there are two questions here.
1. PE firms hire investment banks to manage the negotiations and BS work like updating slides, creating decks and managing truckloads of due diligence items. They are not expected to reinvent the wheel or know a PE firm's industry and strategy better than them. But they are certainly happy to do awful work over the weekend so the PE teams don't have to touch it.
2. PE hires investment banking talent to come work in PE because they have a consistent training background. Someone from a top IB firm has reliably gotten solid modeling and deal reps. There are 100% talented people elsewhere in finance, but it's very difficult to gauge what their skill level and training is. That's tough in a PE because it's not set up to provide people a lot of training... if you are smart but can't model, you're not going to have a fun time as an ASO in PE.
PE is not rocket science either. The basis is buying companies and identifying a few levers to improve the business and sell them for more, you don't necessarily need the most amazing thinking, wonderous slides and wildly perfect forecasts - it just doesn't make a difference, firms aren't buying companies because of the slides. All forecasts are made up anyway. If you want a "deep thinking" role with bottoms-up bespoke analysis, IB/PE are not it.
Thank you for the answer! On point 2 looking at the US, we see ~20% of corporate equity managed by Private Equity firms, now my questions is if external factors become more unfavorable will this impact the industry? Considering the amount of secondary buyouts the argument that „we improve operations“ does not hold that much if it is the x time the company got sold to a PE.
Additionally, if there is not much room for improvement, or in general to pick top companies, will the PE market turn to a kind of overly expensive crowd of „activist investors“ that use lots of leverage (which works if earnings go up, but does the opposite if earnings go down)? If the share of controlled equity rises the main reason for return will be leverage given that the assumption „we only pick top companies“ does not hold that much anymore. Also forgot about the transaction costs. You could just start to nearly blind pick companies and reduce cost by cutting staff. Assuming the „valuation“ part become a bit less important since the highest bidder takes the company and also given the fact that this is a lot driven by external factors.
Ps just writing this out of meeting and out of my mind, please don’t kill me for minor mistakes
(1) The lock-in effect. It is very similar to why MBB gets hired so often. It isn't because they are the best or because their advice is actually needed but because it is a way to CYA. Much harder for your boss/board/etc to say you made the wrong decision when MBB is telling you to do it.
The same thing applies to PE recruiting, at least for the larger funds. There are better ways to get good investors, but it is as much about CYA than anything else. Especially since so much of larger PE firms being... a conveyer belt.
(2) For larger funds, there is a genuine benefit to this. Industry knowledge isn't as important here. Most of the returns at this level are primarily created through financial processes, not underlying business growth. IB does provide a training ground for these types. That isn't to say this is sufficient justification, just that it isn't totally devoid from reason.
(3) "most CIMs I have a read on both sides IB/PE are of very poor quality, really just poor marketing slides with little to no added value."
CIMs are literally marketing documents. You are complaining about a marketing document being a marketing document
From my experience not necessarily, Ive seen a lot of people get hired from different backgrounds Big 4 and Consulting as well, or even different fields
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