Comparing Investment Banks, Hedge Funds and Private Equity

I'm a incoming freshman at the undergraduate level, and was wondering if someone could give me a quick simple, basic breakdown of the differences between IB, VC, PE, and Hedge Funds?

Investment Banking vs. Venture Capital

Investment bankers are advisors that work with companies to raise capital for investment in the business through debt and equity offerings and advise on transformative M&A transactions.

In investment banking there is a strict hierarchical structure that typically goes like: analyst, associate, vice president (or director depending on firm), senior vice president, managing director, C-suite.

Investment bankers are in the financial services industry and are at the beck and call of clients and therefore analysts and associates are often called to work long hours meeting clients demands. Analysts frequently work 65 - 85 hour work weeks.

Read More About Investment Banking with the below WSO Articles

Venture Capital Overview

On the other hand, venture capital refers to financing start-up companies and small business that have long-term potential. Venture capital does not always mean monetary investment but can also be in the form of technical/managerial advice. While venture capital may seem similar to private equity, vc specifically seeks smaller and emerging companies.

Below are some characteristics of VC firms:

  • Invest in startups
  • Invest in less than a majority of equity in a company
  • Prefer to diversify across a broad array of startups as they are unpredictable and often fail
  • Venture capital firms invest in startups in technology, clean technology, and biotechnology

Venture capital firms invest in companies with both a high risk and a high reward. Because of this, they spread their investments more to prevent a failed investment from significantly impacting the fund.

For VC firms, the hierarchy is similar with differences in senior positions: analyst, associate, principals, and partners. From a compensation standpoint, associates in venture capital can expect to make anywhere from $130-250k.

You can check out a video about VC below.

You can read more about VC and PE in this detailed thread on WSO.

Private Equity vs VC vs. Hedge Fund

Private equity is similar to VC as they invest money into a company, but PE favors more established, private companies. There are several characteristics of a private equity firm that set it apart from a venture capital firm.

  • Invest in established companies.
  • Work with companies on operations.
  • The goal is to improve efficiency, which then improves the bottom line.
  • Typically acquire 100%, or at least a majority, of the companies they invest in.
  • Invest in a wide variety of companies. If a company's processes can be improved, then it has a distinct appeal to private equity firms.

Private equity firms, unlike venture capital firms, invest in established companies that are somehow struggling. They then work with the companies over a period of time, which varies, to streamline the business, improving efficiency and, as a result, profits. They can do this because they acquire 100% or a majority stake of the company.

Private equity has a similar hierarchy to IB: analyst, associate, vice president, director/partner.

Hedge Fund vs. PE

A hedge fund's goal is to provide the greatest returns as quickly as possible. HFs tend to invest in highly liquid assets (stocks, short selling, options, bonds, futures, currencies, virtually anything and everything) which can turn a profit. They will then quickly flip to another asset. Due to the extremely liquid nature of HF, investors can cash out at any moment.

Hedge fund hierarchy follows as such, with some variation between firms: analyst, associate, portfolio manager, partner, president, c-suite.

Often times analysts coming from IB backgrounds are faced with the decision of which career track to recruit for - PE vs. HFs. What is important to understand is that PE and HFs have very different work flow. Private equity is often thought of as banking 2.0. Instead of making pitch decks, you are reading CIMs and building out financial analysis to help the partners determine if an investment is justified. On the hedge fund side, you will be working on idea generation and research. Hedge fund work is typically very meritocratic while PE remains very hierarchical.

You can read more about getting hedge fund jobs and internships on WSO.

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Comments (58)

Best Response
Apr 2, 2015

IB: help grant companies access to financial markets. They perform a variety of duties from advising companies on mergers, acquisitions and restructurings, to helping them issue debt/equity. Basically help companies raise money.

VC: Invest in companies that are usually at an early stage of life, usually in exchange for equity. Once the company grows sufficiently and "exits" the VC portfolio, usually through an IPO or acquisition, the VC firm cashes in on its equity share.

PE: A little similar to VC, however, there are many key differences. PE firms usually invest pooled capital taken from many outside investors into companies that are more developed and have inefficiencies. The PE firm will, in the case of a public company, take it private (delist from a public exchange), shake up the company (change management, better the balance sheet, etc) and then float the company in an IPO or sell it to cash out.

HF: another type of strategy that pools investor money to invest in public markets. Funds can hold public equity, or debt. They can also specialize in distressed companies and invest throughout their capital structures. Still others capitalize on the impact a merger will have on the acquired/acquiring companies. The universe here is quite large, with firms having different specializations.

Very, very basic, but should give you an idea of each industry. Try googling or searching this site for more detail. Whole books can be written on each industry. PM me if you want more detail.

    • 11
Apr 3, 2015

Out of curiosity, which of these involve the most mathematical skills and usage? Is VC a math heavy industry?

Apr 2, 2015

IB = advising clients on transactions (M&A, IPOs, etc.)
VC = investing in early stage growth companies
PE = buying more mature (compared to VC) corporations and taking them private (if they weren't already), and using debt and careful management to (hopefully) earn large returns.
HF = Investment vehicle designed to achieve absolute returns. In reality, hedge funds can invest in almost anything, but the technical definition involves using market-neutral strategies such as buying a stock and shorting the sector it's in, or pairs trades, etc. Many funds and strategies don't follow that to the letter, however. More broadly, hedge funds are investment vehicles that are lightly regulated (compared to mutual funds) and can invest in almost anything, but are limited in who can invest with them.

    • 2
Apr 2, 2015

Solid responses above. Another way to think about it is by type of involvement and ownership. Some loose rules of thumb to go by (always exceptions):

IB - service provider to companies; seldom if ever own any equity in the business; no board seats
VC - generally a minority ownership, investing capital to help a business grow; board observation, sometimes a decision maker
Growth PE - minority owners of more mature companies than VC; board observation, sometimes a decision maker
Buyout PE - majority owners of mature businesses as stated above; board seat(s) and decision maker
Hedge Funds - nothing to add to definitions above

    • 1
Apr 3, 2015

Hedge funds can be extremely math-intensive, especially on the macro and quantitative finance strategies. VC is the polar opposite for the most part, with very little math involved (mostly networking with entrepreneurs, research-oriented due diligence). However, because you're evaluating young/emerging technologies, a technical background is helpful so that you can understand the potential implications of the opportunities that cross your desk, and speak intelligently with entrepreneurs.

Private equity and investment banking models typically involve simple arithmetic.

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Apr 3, 2015

What would be the best way to enter VC or PE after undergrad?

Apr 3, 2015

Networking is the best way. If you're going to Wharton, Harvard or Stanford, there are certain PE/VCs that will recruit on campus.

If not you'll have to pull your own weight, network to get relevant internships, and do some heavy lifting to differentiate yourself from the hundreds of other students who want to join the buyside after graduation.

For VC, that may mean starting a company that experiences some level of success (even if it's super low level, but people have to use your product), or being very active in computer science and entrepreneurship organizations on campus. VCs are also very referral-oriented, so it's important you network with local entrepreneurs and VCs to get your name out there in the community.

For PE, it may mean picking up part-time internships at investment banks or private equity firms, and otherwise just demonstrating that you have the technical skills as well as the investment acumen to really add value.

Knowing what exactly you want to do at this stage will be particularly helpful in a few years when you're going through actual recruiting processes, and as more and more PE firms turn to undergrad for analysts, you'll have many more opportunities to go directly to the places you want to join.

Apr 5, 2015

Investment banking groups provide advisory services to clients. The vanilla version of this typically consists of valuation in preparation for a strategic transaction, whether it be a capital raise (company raises money, either through equity [IPO] or debt [corporate bonds]), or an M&A transaction (a company is either selling itself, getting bought, or seeking to buy a competitor). Bankers come up with a price, an approach to the deal, and knock out speed bumps so that the deal goes to completion.

So if Apple wanted to buy Tesla, they would turn to an investment bank and work through a good (lowest possible) price to approach Elon Musk and Tesla's shareholders to agree to sell. Tesla would likely retain another investment bank to advise on the other side of the deal - the maximum Apple is likely to pay and what level shareholders would be happy with.

Investment management firms control a pool of money that they put into a variety of different things - there are an infinite number of different strategies. Some firms buy stakes in healthy companies and hope that long-term price increases and dividends will achieve a stable return (many mutual funds focus on this). Others buy stakes in troubled companies, sell off underperforming assets and either scrap the company entirely or put in place strategies to get the company back on the map (distressed investing). Private equity firms will use debt to finance a large portion of the transaction when they buy a company (leveraged buyout), which helps magnify returns on an investment. Venture capitalists invest in young companies. And hedge funds invest in everything imaginable (legal rulings, wine, gold, mergers, etc.)

Investment management is very different from investment banking - so different that the two very rarely have overlaps. The obvious overlaps are 1) when an asset manager buys another asset manager (nothing to do with Asset Management, just an M&A transaction that's advised by an investment bank) and 2) when a private equity firm (or hedge fund, or whatever) is seeking to take majority control of another company. Typically an investment bank will offer valuation advice and provide the debt financing needed.

Some investment banks also offer fundraising services for investment management firms.

But note from the above that investment bankers do NOT invest.

    • 2
Apr 5, 2015

Thank you so much for your help. Your responses have helped me tremendously! :)

Apr 6, 2015

Also just as a word of caution, when you read about "Investment Banking" from various news/media sources they usually are referring to something different than what finance people (people on this forum) mean when they say Investment Banking. Here, we consider the advisory business including M&A and capital markets transactions. The media refers to this AND Sales and Trading usually when they say "Investment Banking". This confused me for a while so just be careful to know what you're reading/who you're talking to

    • 1
Apr 6, 2015

Glad I could be of help :) Also sent you a PM.

Apr 5, 2015

I also just sent you a PM with one more question. But, let me know in this thread if you did not receive it because my internet lagged when it was sending.

Apr 9, 2015

In response to one of your earlier questions about whether or not VC is a math heavy industry, it depends on what type of VC firm you join and what your specific job is. If you work for a VC firm that invests in early stage pre-revenue companies, no, you won't be doing a lot of modeling. On the other hand, if you work at a firm that invests in late-stage firms, you will be doing modeling.

Apr 9, 2015

IB: go in for the Training
VC: dont do that
PE: after IB if you are a financial strategist
Hedge Fnds: after IB if you are a Quant

    • 4
Apr 9, 2015

misguiding to say the least.
IB: you go in not only for the training, but also for the experience.
VC: I don't see why not. If you have an genuine interests in technologies, entrepreneurship, and finance altogether, VC is your way to go. As a former VC intern, I have to tell you that VC relies more on gut than on numbers, which is not my cup of tee.
PE: "Financial strategist"? What?
HF: L/S, Distressed debt/equity. these are all examples of non quant hfs.

Apr 9, 2015

IB: duh, you can do everything for the experience, you can even do IB, VC, PE and HF for the experience. But as a matter of making a choice. You go into IB for the Training.
VC: my Cup of tea is numbers as well, that is why I said to not do that (but I should have stated that reason, so thumbs up for adding that Argument)
PE: you will use finance and Business knowledge
HF: hedge funds use quantitative techniques if you have not noticed

    • 1
Apr 9, 2015
kyc133enydc:

misguiding to say the least.

I agree

Apr 10, 2015

Ib its like learning how to drive a car
Vc you are like a pirate looking for treasuries
Pe you are playing with the big boys
Hf did you like physics in high school? Were you bullied because of your nerdy glasses and autistic behaviour? Then hf is the perfect place for you

    • 2
Apr 10, 2015

I would suggest that you stop spreading misinformation on this forum.

Apr 10, 2015
kyc133enydc:

I would suggest that you stop spreading misinformation on this forum.

Totally agree. There are so many different types of hedge funds. Not all of them are quantitative!

Apr 11, 2015

They are all the same. You need a job in banking first! LOL

Apr 11, 2015

"Why not intern/become an analyst at a PE/HF/VC and work your way up and lateral into a bigger/more reputable firm?"

My understanding is that this is not typically done. They are usually looking for analysts with sell-side experience who have seen lots of deals, not buy-side experience.

Apr 11, 2015

Okay, I had no idea. Thanks for info. Makes much more sense now.

Apr 11, 2015

why not just become a fucking baseball player like me and make bank. now take a hike, sport.

My drinkin' problem left today, she packed up all her bags and walked away.

    • 1
Apr 11, 2015

I'm no expert but basically what's been said above: being able to understand how the sell side works allows you to be better on the buy-side.

However, it seems like for those interested in hedge funds and not PE, IBD is not necessarily the only route - but it still seems to be really highly regarded.

Apr 11, 2015
RonaldBacon:

Also, is it easier to get into IBD from PE/HF/VC or the other way around?

This has been on my mind for a while because I want to do IBD, but I'm not sure if I should take a PE internship over an IBD internship. And, I'm not sure if I want to continue in IBD as a career or jump ship to the buyside.

Other way, but you won't want to. And everyone gets to point where they are ready to get out

Apr 11, 2015

Thanks, very interesting

Apr 11, 2015

Thanks, very interesting

Apr 11, 2015

I take it that's US$?

Apr 11, 2015

Ibanking numbers are pretty accurate for last year's bonuses

PE is a little light, may fit for the mid market, not large cap

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Apr 11, 2015

I agree, the PE numbers do seem to be a little on the low side. But carry does make up a significant portion of comp, sans analysts.

Apr 11, 2015

I didnt realize that fund of funds compensation was so low( relative to HFs of course.)

Apr 11, 2015

Oh, and the 50bps of carry for an associate can equal 2.5MM at a 500mm fund, and 5mm at a 1b fund.

Apr 11, 2015
Kasanova:

Oh, and the 50bps of carry for an associate can equal 2.5MM at a 500mm fund, and 5mm at a 1b fund.

Dude, that is not how carry works. Notice how ridiculously high your numbers are?

Apr 11, 2015

carry isn't given at many firms. Funds will allow you to co-invest in deals and also let you buy into a fund with little to no minimums.

I'm going to a top 5 tech buyout fund and we don't get carry.

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Apr 11, 2015

point taken.What are the comp numbers like where you're at?

Apr 11, 2015

Haven't started im rounding out my 3rd year. Shedding some light.

Last year 70k + 100k bonus
This year 80k + TBD bonus

Fund 105k salary, 25k signing bonus, TBD bonus

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Apr 11, 2015

what was your first year numbers?

Apr 11, 2015
<abbr title=bulge bracket&#10;>BB</abbr>.MandA.3rdyear:

Haven't started im rounding out my 3rd year. Shedding some light.

Last year 70k + 100k bonus
This year 80k + TBD bonus

Fund 105k salary, 25k signing bonus, TBD bonus

what was your first year numbers?

Apr 11, 2015

Uhh, dude....thats not per year.

Apr 11, 2015

You have your idea of carry wrong. Carry is not your percentage multiplied by fund size.

Carry is calculated this way (at most places I know)

Carry % * Fund Profit (which follows 2/20 rule, so 20% of whatever fund makes)

So if you have 1% carry at a $1 bn fund that in its life earns an IRR that allows it to triple to $3bn you make (1% * 2bn * 20%)= 4 million.

Apr 11, 2015

Typical lifetime of a fund = 3-5years?

Apr 11, 2015

my first year was different than the prior year

i got 55k+10k moving+5k relo+60k
last years got 60k+10k+5k+ (60-80k) bonus

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Apr 11, 2015

Tier 1 Bulge (GS/MS/UBS LA) and Tier 2-3 Bulge are expecting numbers to increase, this will be confirmed with associate payout

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Apr 11, 2015

Does anyone have a view on whether these numbers are
on the money?

http://www.nypost.com/seven/12112006/photos/biz037...

Apr 11, 2015

Associate numbers haven't been announced yet at my firm or any bulge that I no of... if those are even close analyst bonuses will be RIDICULOUS

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Apr 11, 2015

those numbers seem very high...i dont see analyst bonuses rising that much and i expect a class of 2007 analyst to see his first and second year bonuses drop a bit.

Apr 11, 2015

ok, good - that's what I was thinking too! I wasn't sure if that was speculation or not although who knows. I'm reading a lot about firms in London culling staff in order to pay top dollar to star performers.

Apr 11, 2015

Question....Don't PE funds get both a carry and a management fee? I think I was confusing the carry fee with the management fee( I assume that they are normally around the same %, except that carry isn't received until after the exit)

Apr 11, 2015
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Apr 11, 2015
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Nov 26, 2017