What is the Difference Between Private Equity and Private Wealth Management?
I have been asked by students just entering the study of finance about the difference between private
equity and private wealth management.
Private Equity (PE) is one of the most sought after types of work
in finance. The traditional route into private equity is: spend two years at an
investment bank and then complete an MBA at a top business school. For an
excellent insight into the Private Equity world, read Barbarians at the Gate which details the leveraged buyout (LBO) of
R.J.R. Nabisco by KKR in the 1980s.
Private Equity is not very well known outside of the finance
world, but it is one of the key players in global business. Private equity
firms are part of the ‘buy-side’ of the investment industry and some of the
largest firms are: Kohlberg, Kravis & Roberts (KKR); Blackstone; Bain
Capital; and Carlyle Group.
The definition of private equity is simply money invested
into a private company, or the privatization of a company through the
investment of outside money. Basically, what private equity firms attempt to do
is to invest into a company, take a majority stake, improve the company and
then exit their investment at a large profit. In order to magnify returns, PE
firms make use of leverage (borrowed money) to conduct LBOs.
Private Equity firms can either focus on a specific sector (Software,
Biotech, Energy, Technology, Healthcare, etc.) or operate across a broad
spectrum. The larger the firm, the more likely it is to cover more sectors.
PE firms will typically acquire 100% of the target company
and make use of a combination of cash and debt to finance the acquisition. The
advantage of using debt is that the firm has to invest less of its own cash,
and therefore the return on equity is higher and they can undertake bigger /
more investments. When the target company is acquired, the future cash flows
are used to pay off the debt used. If the PE firm in question is using
leverage, they will require a financial sponsor (typically a bank) to loan them
the money.
The aim of the investment by the PE firm is to take a
business, increase its value and then sell it’s share in the business.
Typically, PE firms will target 20% return per year. The way the firm will
improve the business can be anything from replacing the management, reducing
costs, improving efficiency or many other possible actions. Private Equity
investments are usually not that risky (at least compared to venture capital) because the
target firm is usually quite large and is unlikely to collapse in value.
As a junior employee in PE, your work is actually quite
similar to that of investment banking, but the hours are usually less and the
pay is usually more. The work will involve valuing companies, modeling for
mergers / LBOs, conducting discounted cash flow (DCF) analysis, fundamental
industry analysis, etc.
Private Wealth Management (PWM) is a service offered by
institutions to high net worth individuals and firms. The services typically
offered with private wealth management include:
·
Investment advisory
·
Money management
·
Wealth planning
·
First priority product offerings
Private Wealth Management is frequently part of the ‘Private
Bank’ sector of a bank. Private Banking (PB) is a form of wealth management
service offered to ultra-high net worth individuals ($5mm and upwards). The
services offered by a private bank will include:
·
Portfolio investment ideas
·
Wealth protection through asset investment such
as gold
·
Tax avoidance advice
·
General financial planning including charitable
donations, inheritance, retirement etc.