Investment Banking vs. Private Equity: What is the Difference?
The private equity (PE) industry tends to be a common exit path for investment banking analysts and management consultants.
As a result, we get a lot of questions on both the functional and the actual day-to-day differences between investment banking analyst/associate and private equity associate roles, so we figured we’d lay it out here.
In the following post, we’ll compare the industry, roles, culture/lifestyle, compensation, and skills to compare and contrast both careers in detail accurately.
Simply put, investment banking is an advisory/capital raising service, while private equity is an investment business.
- Investment Banking → An investment bank advises clients on transactions like mergers and acquisitions, restructuring, as well as facilitating capital-raising. Investment bankers generate income by collecting fees for their advisory services on corporate transactions.
- Private Equity → PE firms, on the other hand, are groups of investors that use collected pools of capital from wealthy individuals, pension funds, insurance companies, endowments, etc. to invest in businesses. In short, PE investors are investors, not advisors.
Private equity funds make money from a) convincing capital holders to give them large pools of money and charging a % on these pools, and b) generating returns on their investments.
The two business models do intersect. Investment banks (often through a dedicated group within the bank focused on financial sponsors) will pitch buyout ideas with the aim of convincing a PE shop to pursue a deal. Additionally, a full-service investment bank will seek to provide financing for PE deals.
Investment Banking vs. Private Equity: Differences in Functions?
The entry-level investment banking analyst/associate has three primary tasks: pitch book creation, modeling, and administrative work.
In contrast, there is less standardization in private equity – various funds will engage their associates in different ways, but there are several functions that are fairly common, and private equity associates will participate in all these functions to some extent.
Those functions can be boiled down into four different areas:
- Screening Investments (“Sourcing”)
- Monitoring Portfolio Companies and Operating Performance
- Exit Strategy
Fundraising is typically handled by the most senior private equity professionals.
But associates are sometimes asked to help out with this process by putting together presentations that illustrate the fund’s past performance (i.e. fund IRR), strategy, and past investments. Other analyses can include credit analysis on the fund itself.
2. Screening Investments (Sourcing)
Private equity associates often play a critical role in screening for investment opportunities, i.e. sourcing potential investments.
The PE associate puts together various financial models and identifies key investment rationales for senior management regarding why the fund should invest capital in such investments.
The analysis may also include how the investment may complement other portfolio companies that the PE fund owns.
3. Monitoring Portfolio Companies and Operating Performance
Frequently managed by a dedicated operations team, certain private equity associates – especially those with management consulting experience – may assist the team in helping portfolio companies revamp operations and increase operating efficiency (EBITDA margins, ROE, cost-cutting).
The amount of interaction a PE associate receives in the process purely depends on the specific fund and its investment strategy.
There are also certain PE funds that have associates dedicated to just this part of the deal process.
4. Exit Strategy
The planning of exit strategies involves both the junior team (including associates) and senior management.
Specifically, associates screen for potential buyers, and build analyses to compare exit strategies Again, this process is modeling-heavy and requires in-depth analysis.