Where is the industry going for young professionals?

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Future of Private Equity

At the top a lot of mega funds' equities business has slowed, given the amount of capital invested in the space, the difficulty of growing such large portfolio investments to realize a desired return and market forces. A lot of these funds - Blackstone and Apollo specifically, but the others as well - are rapidly expanding their credit businesses as banks offload these assets due to the new regulatory environment and their desire for the consistent cash flows that credit provides.

The middle market is saturated with firms and over served. With valuation multiples and the amount of capital overhang, it seems that returns in this space will also be compressed for quite some time. Traditional "generalist" models of investing are proving difficult to successfully implement and many of the more successful firms are employing specialist strategies or concentrating in a specific niche to drive value.

Career-wise, partner track is not very common. The reason so many new firms came into the market was because of this fact combined with the demand for these types of investment vehicles. If you can't make partner but have years/decades of experience, go open up your own shop and raise some capital. This is also extremely difficult to do nowadays as the competition for funds is so intense.

Further, the possibility of carry being taxed as income is increasing with each presidential cycle.

Given these facts, will PE remain in high demand as an exit from banking? Can mega funds continue to pay outsize salaries to its employees given the difficulties they face? Will they be shrinking their equities businesses? Will middle market professionals find their salaries deteriorate as IRR expectations dampen, co-investment demand increase and carry taxation increase?

Does PE still have the same level of interest as it used to for young professionals looking to make the jump from banking to the buy side? Can they still expect comparable salaries? If not, where do you think a lot of professionals will become interested in going?

Comments (24)

 
Oct 13, 2015 - 1:28pm

rionexpa:

Returns will come down on the average (many funds already underwrite to IRRs 500 bps below pre-2008). Pay will remain stable at large funds as it's become an AUM game (look at TPG / Carlyle / KKR latest fund IRRs). Crowded markets are more competitive and top-quartile funds (H&F) will continue to warrant top-pay.

Thanks for the response. Flagship funds at mega funds have decreased in capital raised so these firms are focusing on smaller, specalized investment vehicles (e.g. Carlyle's $2.5 bn energy fund). They are also building out other businesses to diversify, which is why I mentioned the increase in large funds' credit businesses. Do you mean AUM in aggregate across the firm or within certain funds/divisions?

Also, is it possible to be a consistent top-quartile fund? Doesn't fund performance vary across funds so much that top performing funds in one cycle might not be on the list in the next cycle?

 
Oct 13, 2015 - 1:44pm

I think your assessment is correct. Look at Vista. What was traditionally a killer-SaaS/IT PE shop has begun launching credit products. Once you're large enough it becomes very difficult to compound at 25% p.a., the business model tends towards aggregating as much under management as possible and making it rich off of management fees. It's not surprise Apollo, Ares, Carlyle, etc. have chosen this route.

Your last question: yes, performance varies across funds. I think, in general, as long as you have a top-quartile fund within some relatively recent vintage (and it's a sizable fund), the firm will attract top-talent and pay out accordingly.

 
Oct 13, 2015 - 2:19pm

I think the best opportunities ahead are funds willing to roll up selves, get dirty (operationally heavy) in the lower middle market space (sub ~$20m EBITDA)

agree w/ everything above... megas are getting rich from mgmt fees, multiples are sky high, returns have been depressed for some time now. not sure what you guys are seeing out there but 10-15% average is considered "good."

 
Oct 13, 2015 - 4:09pm

The lower MM has its own issues and expected returns have also depressed. It has never been more difficult to find a proprietary deal, and a ton of debt and equity capital has been raised down here, too (and if you don't have capital, no worries; fundless sponsors are securing deals). Valuation and leverage multiples are at all-time highs.

 
Oct 13, 2015 - 4:31pm

ThaVanBurenBoyz:

The lower MM has its own issues and expected returns have also depressed. It has never been more difficult to find a proprietary deal, and a ton of debt and equity capital has been raised down here, too (and if you don't have capital, no worries; fundless sponsors are securing deals). Valuation and leverage multiples are at all-time highs.

i work in lower mm PE and i agree but proprietary deals have been disappearing in the last decade, this is nothing new. what is new however... is when bankers put you through 2 rounds of bidding post IOI, that is just crazy.

 
Oct 13, 2015 - 7:49pm

ThaVanBurenBoyz:

The lower MM has its own issues and expected returns have also depressed. It has never been more difficult to find a proprietary deal, and a ton of debt and equity capital has been raised down here, too (and if you don't have capital, no worries; fundless sponsors are securing deals). Valuation and leverage multiples are at all-time highs.

I worked in a lower middle market FoF. My job consisted of evaluating funds in this sector and this answer is pretty much spot on.

However, some of the funds we invested in (about 1 in 100 funds screened) were consistently making 3-4x cash on cash returns so there is still money to be made.

 
Best Response
Oct 13, 2015 - 4:31pm

All great questions. The answer is that the career isn't what it used to be-I wrote about it here:

http://www.wallstreetoasis.com/forums/5-ways-a-career-on-ws-is-not-what…

Without a doubt talk to anyone on the inside and they will tell you that the business isn't as lucrative as it used to be.

An interesting way to answer this question is to look at what is happening at the top. Many senior people recognize the career isn't what it used to be and they're leaving. Take one of my clients who was a senior guy at a mega-fund. He didn't feel that he had made the wealth he expected after more than a decade in the business, and looking ahead knew that he would never be a key decision-maker nor play the type of role he wanted.

That said, at a junior level the buy-side is still an incredible opportunity. Staying in banking isn't what it used to be either, and where else do you get the type of experience and comp that you get on the buy-side. Even if you're not around for the end-game, it's an incredible job to build up capital, your network, and position yourself for different types of opportunities.

My view on any job on Wall Street is the same-if you know why you are there and direct your career to achieve your goals, it's still a phenomenal opportunity.

Former banker and investor, advisor to senior Wall Street pros. Learn more at geoffblades.com
 
Oct 13, 2015 - 10:14pm

geoffblades:

All great questions. The answer is that the career isn't what it used to be--I wrote about it here:
//www.wallstreetoasis.com/forums/5-ways-a-car...

Without a doubt talk to anyone on the inside and they will tell you that the business isn't as lucrative as it used to be.

An interesting way to answer this question is to look at what is happening at the top. Many senior people recognize the career isn't what it used to be and they're leaving. Take one of my clients who was a senior guy at a mega-fund. He didn't feel that he had made the wealth he expected after more than a decade in the business, and looking ahead knew that he would never be a key decision-maker nor play the type of role he wanted.

That said, at a junior level the buy-side is still an incredible opportunity. Staying in banking isn't what it used to be either, and where else do you get the type of experience and comp that you get on the buy-side. Even if you're not around for the end-game, it's an incredible job to build up capital, your network, and position yourself for different types of opportunities.

My view on any job on Wall Street is the same--if you know why you are there and direct your career to achieve your goals, it's still a phenomenal opportunity.

Where will the comp be then? Hedge fund? Or just nowhere because growth is so stagnant in general?

 
Oct 14, 2015 - 8:09am

I tend to think about it differently.

We've emerged from a period of abnormal comp. If you got back decades investment banking was nowhere near as lucrative as it was through the 80s-00s. The same is true for HF and PE, which saw an explosion in AUM.

And even then these industries benefitted from enormous inefficiency-e.g. when Bondemann set up TPG in the early 90s, the PE industry was a wide open field of opportunities relative to today where the big buyout shops are mostly just selling assets amongst themselves...

Also recognize that comp always flows to the creators who bet on themselves and build their own firms. IMO they deserve outrsized comp. Today comp is becoming commoditized BC the economics aren't what they used to be (e.g. fund sizes, performance) and because the business has become generic.

There are still however pockets for creating outsized returns. Startup boutiques like centerview have crushed it and many platforms in hf and pe are still incredibly lucrative. but, the old rules apply.

if you're gonna get a job and work for someone else as mostly a substitutable resource (e.g. a generic MD at Goldman is substitutable with a generic MD at Morgan, and so too is a generic partner at KKR or carlyle), then you shouldn't expect to earn outsized returns.

comp is where you can create value. stagnant growth makes it harder, but those who create enormous value in the world (e.g. vista equity partners or uber or any other number of places) will still earn massive rewards.

Former banker and investor, advisor to senior Wall Street pros. Learn more at geoffblades.com
 
Oct 13, 2015 - 8:42pm

I probably wouldn't get into it today with the intention of being a lifer. All of the reasons above are accurate. I can't say with certainty a better career option and you'll probably still make more than 99% of the population but I don't see the big returns and therefore big comp out there and I can't imagine starting your own fund up in the foreseeable future. Saying that the space is overcrowded from when I got in 15 years ago is an understatement. I've been in lower MM to MM deals for most of my career and it used to be more Wild West and less rep'd by bankers. That not only meant deals could be more lucrative but they could also be more creative and fun. Now it seems like almost every deal is the same and kinda blah.

I'd probably get a few years experience in PE, figure out how deals work, how to finance and exit them, build a network up on the finance side then jump to an exec ops/fin role, get a few years experience on that side of the ball and then try to buy a company in an LBO/MBO and run it.

 
Oct 14, 2015 - 2:02pm

I'd be more optimistic about sell side IB. There are plenty of banks and bankers to be clear, but there is still a swath of the senior-level individuals that will be retiring over the next ten years. Simultaneously, there are plenty of businesses that will be transitioned.

Thus far, despite the availability of deal platforms and other tools, investment banking remains relevant and irreplaceable by technology. It's hard to replace the value of qualitative factors (e.g. relationships, sector expertise, negotiation skills, process control).

 
Nov 12, 2015 - 5:53am

undefined:

I probably wouldn't get into it today with the intention of being a lifer. All of the reasons above are accurate. I can't say with certainty a better career option and you'll probably still make more than 99% of the population but I don't see the big returns and therefore big comp out there and I can't imagine starting your own fund up in the foreseeable future. Saying that the space is overcrowded from when I got in 15 years ago is an understatement. I've been in lower MM to MM deals for most of my career and it used to be more Wild West and less rep'd by bankers. That not only meant deals could be more lucrative but they could also be more creative and fun. Now it seems like almost every deal is the same and kinda blah.

I'd probably get a few years experience in PE, figure out how deals work, how to finance and exit them, build a network up on the finance side then jump to an exec ops/fin role, get a few years experience on that side of the ball and then try to buy a company in an LBO/MBO and run it.

This seems like excellent advice and also further speaks to the point on how comp shouldn't really be the distinguishing factor between going the sell side route or going into private equity. The role is quite different at the top - banking tends to focus on sales/relationship management, while PE is investing + execution, and HF is really just investing. Lots of the heads at various private equity firms came from mid level positions (associate, VP) positions in banks that learned how to drive execution in processes very well in banking and combined that skill with a knack for investing to produce strong returns via closing deals and hitting targe numbers post close. Problem now is that the process seems to be so refined (from my humble analyst perspective) by bankers on the sell side that it's hard to drive additional value through deal execution and the management team really needs to execute strongly if you want to do well. In addition, the rise of activism has made it harder because frequently activists are having the changes private equity firms would normally make be enacted in the public markets.

So far (and this may change) I'm trying to learn process management in banking, hoping to learn financing/exiting deals via PE, and as Dingdong08 said try perhaps move towards an MBO style kind of executive. From the meetings I've been in private equity firms, there is a focus on assets that are earning below their potential and the partners of these firms tend to name drop certain executive ("I'm sure I could drop Jim from ___ in here and he'd have the company doubling earnings power in a few years) - and these are the guys who make the real money.

Multiples and prices could come down, but there's too much money flowing into alternatives, so one is unlikely to see returns come back to where they were. Even worse, once the private capital tech bubble bursts (it has already begun to deflate - apart from market leaders more companies are finding it difficult to raise capital, couple of mutual funds that dipped their toes into the space are slashing the valuations of their stakes, companies are going public below their last private round valuation) - money that funds like KKR, TPG, etc who were traditionally not growth/venture players will likely come back into traditional buyout oriented strategies.

Seems like one's goal should be to go to a brand name shop - pick up skills/network, and then develop a competency/strategy in a certain space. Vista has been mentioned a few times on this thread - Vista, Thoma Bravo, Francisco, Vector, etc have done well recently by buying up legacy software assets (read: TIBCO, Informatica, Solarwinds, Hyland, Compuware, BMC Software, etc), consolidating the space, slashing costs, transforming the revenue structure from perpetual license to a recurring revenue model, and leveraging the cash flow conversion/margin profile to make money. Such a strategy would be very difficult to enact in the public markets because transforming the revenue structure from perpetual license to recurring revenue requires initial dips in revenue and public markets don't tolerate such. Furthermore, while multiples are high there are certain spaces like this one where investors have flocked to the high growth names and left these assets for dead.

Perhaps a similar opportunity lies in OFS - roll up over-leveraged assets that have low utilization due to current crude prices (though this requires timing and a view on macro crude), consolidate, slash costs and make a lot of money once utilization comes back up. Apollo made a killing with Lydonell when they managed to (either by luck, providence, or intelligence and with the backup of brilliant management exec Jim Gallogly) consolidate low cost ethelyne producing plants, slash costs, and once pricing came back up via demand for the chemical in fracking made enormous returns on their investment. It required doubling down on Lydonell in bankruptcy - perhaps Dell/EMC will work out the same way by doubling down on legacy storage/hardware assets. Either way, the easy pickings seem to be gone. You need a brilliant management team and a willingness to buy undeperforming assets and turn them around.

Or you could just be brilliant like H&F and buy fantastic assets that never lose. Don't know how those guys do it.

The point is that you can still make money - it's just harder. And like anything else, it will weed out the people who don't belong there. I see it in my analyst class less and less people want to do PE, more people want to chase startups so they can cash out via options in the next large private round. But if you're interested and have an appetite for it, I think there's still an opportunity and its even better now because hey, there's less competition. At the end of the day, you really have to genuinely find the work interesting and be good at it - if you love the fast pace, selling, and constantly moving to the next transaction stay on the sell side.

 
Oct 13, 2015 - 11:38pm

Still probably has better chances comp wise compared to tech/medicine... bounce around firms for a decade and a half and you probably should be director at some place by then. Comp is relatively capped at F500s and start-ups are always a crapshoot.

 
Oct 14, 2015 - 10:30am

I agree with most of the sentiments posted. I've noticed that LPs are emphasizing fees more and more as the number of options in the MM has increased. At some point, the asset class will be viewed as a commodity by LPs. I can see a potential for deal-by-deal shops gaining popularity and smaller pensions, endowments, etc. hiring individuals or consulting firms to provide advice on which deals to participate in.

With minimum equity contribution levels at ~30% and new limits on leverage (which can be circumvented), the benefits of leverage have gradually eroded. I have seen funds begin to over-equitize investments in recent years. This provides greater down-side protection and allows them to put capital to work faster and raise a new fund quicker.

After all, if the subordinated debt on a portco is making 10% interest in a low interest rate environment. Is the targeted 15-20% equity turn worth the risk?

Play the long game - give back, help out, mentor - just don't ever forget where you came from. #Bootstrapped
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