Difference Between Investment Banking and Private Equity

There is a huge difference between investment bankingInvestment BankingInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more and private equity. We will bunk the myths here and see how they differ from each other from different angles. Many people often think there is not much difference between them as they both deal with raising capital for investment purposes, but they are entirely different if you look closely.

Investment banking is about finding businesses and looking for ways of raising capital from the capital market. In comparison, private equity is about finding high-net-worth funds and investment opportunities in other businesses. Unfortunately, both seem to be coming from the opposite direction to reach the same goal.

We will dig deep and see in detail how these two different career paths ultimately impacted a lot of young professionals in a meaningful way. We will discuss industries, conceptual roles, cultures, or lifestyles, honorariumsHonorariumAn Honorarium is a payment given to someone in exchange for voluntary service.read more, and various skill sets required to thrive in these paths.

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Overview

Assume A is a private equity firm. B is an investment banking firm. Most people with little or no knowledge about this domain would equate the two as similar, but there is a significant difference. Firm A is a collected pool of investors who invest in reputable businesses. So how would they do it? They would use their pension funds, collect money from insurance companies and wealthy individuals, and invest lump-sum funds in the businesses they think would generate a greater investment return.

Now, firm B is completely different. Firm B does a service of capital-raising for businesses. Firm B advises clients on transactions like mergers and acquisitionsMergers And AcquisitionsMergers and acquisitions (M&A) are collaborations between two or more firms. In a merger, two or more companies functioning at the same level combine to create a new business entity. In an acquisition, a larger organization buys a smaller business entity for expansion.read more, asset allocation, restructuring, and any service that facilitates capital-raising.

So, what is the fundamental industry difference between firms A and B? The basic difference is firm A is an investment business, whereas firm B is a capital-raising service. Thus, private equity is a lot different than investment banking. You do not need to invest anything at your risk in investment banking. Your job as an investment banker is to facilitate and offer consulting services. But in a private equity firm, your job is to invest, not advise. Of course, these two paths often intersect, and often the investment banker needs to pitch ideas to convince the client to do the deal, but both are different industries and pathways.

Investment Banking vs Private Equity – Job Profile

As we already mentioned, both of these things are different. Let us look at what tasks you need to perform if you need to be part of these pathways.

#1 – Investment Banking

Let us talk about investment banking first.

  • In a typical scenario, an investment banking analystInvestment Banking AnalystInvestment Banking Analyst works with investment banking team and expertise in the area of Accounting, Financial Modeling, Project financing, Project Valuation, and Financial statement Analysis. These analyst has deep knowledge in Excel and they are good at VBA to analyze the market data and financial modeling. The analytic work consists of building a financial model for different projects like Infrastructure projects (i.e. Power projects, real estate, etc.).read more has to perform these primary tasks – pitchbook creation, modeling, and administrative work.A pitchbook means buy-side client presentation. As an analyst, you need to understand the market overview, and you also need to take care of the graphical representation of possible exchange ratios.Other than that, it would help to handle multiple deals simultaneously. How would you do that? You will prepare the merger (or any other) model for numerous deals and look for errors and bugs because they would depend on your preparation of the models.You need to be aware of all scenarios. For that, you need to handle sensitivity analysisSensitivity AnalysisSensitivity analysis is a type of analysis that is based on what-if analysis, which examines how independent factors influence the dependent aspect and predicts the outcome when an analysis is performed under certain conditions.read more at different levels.As an investment banker, your administrative tasks would be little or not much. Still, it would help to tweak a few things to concentrate on two main things – pitchbook presentation and modeling on which the major decisions are being made.

#2 – Private Equity

There are four functions that private equity associates have to perform daily – fundraising, screening for and making investments, managing investments and portfolio companies, and exit strategy.

  • Senior professionals typically fundraise, but often associates are asked to help with the presentation. They need to find out the past performance, past investors, and what strategy was used for the funds. Often associates need to do credit analysisCredit AnalysisCredit analysis is the process of drawing conclusions about an entity’s creditworthiness based on available data (both quantitative and qualitative) and making recommendations about perceived needs and risks. Credit analysis also involves identifying, assessing, and mitigating risks associated with an entity’s failure to meet financial commitments.read more on the fund itself.Screening is a very important part of private equity. Associates take pivotal roles in this regard. They look at all the investment opportunities and use financial models (like Discounted Cash FlowsDiscounted Cash FlowsDiscounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company’s future performance.read more, Net Present Value method, etc.) to understand whether investing in these projects is profitable or not.There is a significant difference in creating models for private equity associates and investment bankers. The private equity associates make it to get to the thick and thin of things. At the same time, investment bankers build models to impress clients.While managing investments and portfolio companies, associates help turn around operations and increase operational efficiency (EBITDA, ROE, etc.).They also work on the exit strategy, which needs in-depth analysis. In a go, private equity associates have to be equipped with all the tools, valuation techniques, and finance knowledge to crack the code for their investment portfolioInvestment PortfolioPortfolio investments are investments made in a group of assets (equity, debt, mutual funds, derivatives or even bitcoins) instead of a single asset with the objective of earning returns that are proportional to the investor’s risk profile.read more and their clients.

Work Culture

Choosing any profession besides investment banking is better if you want a work-life balance. Investment banking is certainly not for those who want to work 8 hours daily. However, if you are ready to come to the office at 9 a.m. and leave at 2 a.m. on most days, you can choose investment banking. It is a very high-pressure job. People must put their heart and soul into the deals to fetch them. But, of course, there are two major benefits of working 16-20 hours a day.

Firstly, there is no limit on how much you can earn. So, you can make as much as you want and get a bonus for each deal and the salary.

Secondly, you will always get the opportunity to know the best people in the business. Knowing them will help you crack more deals and become the center of attraction in the business world. But while discussing these two major benefits, most people don’t talk about one of the major things investment bankers often talk about. And it is friendship. If you ask any investment banker, he would tell you that their best friends are colleagues after school or college with whom they cram all night to fetch a major deal. And we think that’s one of the major benefits of this high-pressure job.

Private equity associates spend saner lives than investment banking analysts. If things do not go wrong (they don’t always), private equity associates spend around 8-12 hours daily in the office. Normally, weekends are for them to enjoy their hobbies or with family. That means if you are a private equity associate, you have a much better work-life balance than an investment banker. Of course, sometimes you need to work on weekends, but that is not as much as an investment banker needs to perform. Usually, the team is small (approximately 10-15), and you have the opportunity to discuss various matters with people who are senior to you.

The environment at the office is a kind of cube environment where everyone needs to work on a common goal to achieve the desired result. For example, in private equity firms, associates have more impact on sales and trading as they are closer to taking action and investing. In contrast, investment bankers have less impact on the sales and trading of the business.

In a sense, private equity associates enjoy a better work-life balance than any investment banker.

Compensation

Surprisingly, if you compare the compensation for both professions, you see that investment banking professionals earn less than private equity associates. It is strange, but private equity associates make so much because most private equity associates usually opt to join private equity firms after being investment bankers for some time. So, you can say that whatever hard work they did in their past career, they are getting the benefit now as private equity associates.

Let us look at the compensation of each of the pathways.

As an investment banker, if you join right now, you would get around $130k-$140k per annum in your first year. You may get around $155k-$165k per annum in the second year. In the second year, the increment is visible, but not as much as expected. In the third year, you can expect around $175k-$195k per annum. The above statistics are for investment banking analysts. But, if you join as an investment banking associate, your earnings would be much more in the first year than the compensation of an investment banking analyst. As an investment banking associate, your salary would be around $150-$185k per annum.

As private equity associates, your compensation is significantly more. Still, they do not pay as much as the reputed private equity firmsPrivate Equity FirmsPrivate equity firms are investment managers who invest in many corporations’ private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP.read more in firms just starting. So, in the first year, as an associate, you could get around $100k-$220k per annum. In the second year, you would get around $120k-$250k per annum. And in the third year, as an associate, you could get around $150k-$300k per annum.

Career Pros and Cons

There are many pros and cons to both of these pathways. We will discuss them here to understand what to pick and let go of.

  • It is a job that prepares you for bigger opportunities and makes you the business center wherever you go.It teaches you the beauty of hard work and how one thing focus can yield extraordinary results.It offers you great money. You will not only get the salary very few can earn in two-three years, but you will also earn a bonus that is quite hefty.You will create a network that most influential people cannot. And in this complex business scenario, you know the value of a high-value network.You will create an extraordinary friendship with your colleagues with whom you will cram all days and nights to fetch deal after deal. Most people do not see it as a benefit but ask him about it if you meet any investment banker.

  • An investment banking career is not for the faint-hearted. You must work at least 16 hours and even on the weekend. So, there would not be any work-life balance, and if you do not know how to keep yourself sane, your health may get affected.An investment banking careerInvestment Banking CareerAn investment banking personnel is a motivated professional who aims to help their clients reach their financial goals and objectives. The top four investment banking careers are - Analyst, Associate, Vice president, Managing director.

  • read more is more about business deals than an in-depth analysis of the models. Therefore, an investment banker wants to convince the clients with building models not to go to the depth of any modeling.Investment banking comes down to mainly two things that are not always under control – pitchbook presentation and model building. However, both items are under the clients’ direct control, and the investment bankers use the inputs after considering what clients want versus what they can build.

  • If you want to be part of a great team and facilitate making businesses shine, you would be in a private equity team. On the surface, it may seem easy to achieve, but you need to understand that if you want to be an associate in a private equity firm, you need to know much more than an investment banker.Even if you need to perform an in-depth analysis, your work-life balance would not be an issue. If something does not go wrong, you will be able to enjoy your weekends, and you need to work simply 10 hours a day.In the monetary sense, being a private equity associate is beneficial. That is because you will be paid handsomely at the end of the day.

  • There are not many disadvantages to being a private equity associateBeing A Private Equity AssociateA Private Equity Associate assists other senior associates and partners in identifying a well-suited target to invest in and reaping the benefits by selling it at a profit, as well as overseeing due diligence, handling communication, and preparing financial models.read more. The only thing is that you need to know a lot more as you build models to go to the depth of things as you are on the buy-side of the business. Albeit, you cannot call it a con.You will not get as much limelight as in the investment banking industry.

Investment Banking vs Private Equity Video

Why Pursue Investment Banking or Private Equity?

Investment banking is about getting into the limelight and being the center of attraction. If you are more interested in business selling, you should pick investment banking after MBA from a reputed university.

Private equity is more about passion as it is more in-house than going out and stealing deals. So, if you love to do an in-depth analysis and love investment, you should go for this. But remember, most people who enter this private equity business come after pursuing their career in investment banking.

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