Private equity firms can generally be categorized based on the size and type of investments they make. In the last post, we discussed types of private equity investments based on the stage of their target investments, from venture capital to growth equity to buyout, which correspond to early to mid to late stage investing.
When it comes to size, Megafund private equity firms are those that typically make large investments in established companies and have a fund size of over $10-15 Billion. The companies they acquire tend to have enterprise values above $1 Billion. In addition to the size criteria, megafunds also tend to have multiple fund strategies under one umbrella (LBO, credit, special situations, infrastructure, etc.)
On the other hand, middle market private equity firms typically make smaller investments in less mature companies. Middle market companies can further be divided into Upper Middle Market (“UMM”), Middle Market (“MM”), and Lower Middle Market (“LMM”).
- Lower Middle Market: funds tend to be the first institutional capital into a business. In other words, the target companies might be family- or entrepreneur-owned and generate at least $5MM of EBITDA. Enterprises values of target companies are up to $200MM.
- Middle Market: funds are the next level up. They deal with slightly larger companies, from $200 to $500MM of enterprise value. Middle Market PE firms often buy companies from LMM PE firms.
- Upper Middle Market: funds transact with companies that are big enough to go public, with $500MM to $1Bn of enterprise value. Sometimes, PE funds can team up on deals to purchase larger companies, such as when Zendesk was acquired by an investor group led by Hellman & Friedman and Permira along with ADIA and GIC.
- Megafunds: traditionally used to refer to funds that were $10 Billion+ and did $1 Billion+ acquisitions. However, capital has been a commodity over the last few years, and funds have been raising record high amounts. Some UMM funds like Hellman & Friedman have raised funds well over $10 Billion recently. Generally, think about megafunds as those funds who do large $1 Billion+ transactions that you see in the WSJ. They are massive, global entities that might have multiple funds and strategies under one firm and have the ability to single-handedly do take-private and other complex transactions (Apollo, Blackstone, Carlyle, KKR, TPG, etc.)
Note that the size of a fund can help you back into the number and size of investments it can do. For example, a $1 Billion fund targeting ten investments per year can write ten $100 Million equity checks. Assuming the fund tends to be comfortable with 50% leverage and 50% equity on the capital structure, that means it can do ten $200 Million deals out of the fund.
More detailed differences for various fund sizes are listed below:
- Overview: Funds over $10 Billion that acquire companies worth over $1 Billion. Examples include Apollo, Blackstone, Carlyle, KKR, and TPG.
- Investment philosophy: Megafunds not only have the ability to invest in the biggest private companies, but they are also large enough to acquire public companies (a “take-private” transaction). Because the companies they acquire tend to have mature and proven business models, there may be less room for operational improvements than in smaller companies, so financial engineering may heavily drive returns for megafunds.
- Lifestyle: Megafunds are sometimes referred to as “banking 2.0” when it comes to hours. Because the companies these funds acquire are so large and there are so many stakeholders involved in the transaction, hours can be rough and range from 70-100 hours a week, especially during live deals. The associate role involves new investments and portfolio company work. Associates tend to focus on driving the LBO model and work on due diligence for new investments, with less of an emphasis on operating work at the portfolio company level. Due diligence in private equity is extremely rigorous and requires top level analytics skills, work ethic, and attention to detail, in addition to high social acuity (EQ) when working with sophisticated management teams of portfolio companies and service providers such as bankers, consultants, accountants, and lawyers.
- Compensation: Megafunds pay the most of any private equity firms, with 2021 first year private equity associate comp is $300-$400k ($150K base with variable bonus compensation).
- Recruiting: Most competitive. Megafunds participate in on-cycle recruiting, which means they interview candidates and give out offers ~1.5-2 years ahead of a start date. So, many current bankers and consultants who graduated in 2022 already have signed megafund PE offers to start in summer 2024. Most Megafunds only hire from the top bulge bracket and elite boutique banks, as well as top 3 consulting firms (McKinsey, Bain, and BCG).
- Career opportunities: It is extremely difficult to get promoted past the associate level at megafunds, so many PE associate tend to do 2-3 years at these funds and then attend a top MBA program (mainly Harvard, Stanford, or Wharton), move to a different fund, get an operating role at a portfolio company, move to a corporate role, or start an entrepreneurial endeavor.
Pitchbook noted in its 2021 PE report: “Mega-funds are poised for further growth as more PE firms gear up to take advantage of a relatively easy fundraising period. In 2021, Hellman & Friedman led the pack with a $24.4 billion buyout fund, followed by Silver Lake’s $20.0 billion fund. In 2022, Blackstone is expected to raise more than $30 billion for its next flagship PE fund, which would set a record for the largest buyout fund ever. It would surpass Carlyle’s $27.0 billion target for its 13th flagship fund, which was previously thought to set a highwater mark in fundraising. Along with those two, Apollo Global Management is likely to raise more than $25 billion for its next flagship buyout fund, which would mean three firms alone are anticipated to raise more than $80 billion in 2022.”
Upper Middle Market
- Overview: Funds that acquire companies with $500 Million to $1 Billion of enterprise value. Note that UMM funds can raise billions of dollars, but it is the size of the target companies that drive the definition of this segment. Examples include Berkshire, New Mountain Capital and Thomas H. Lee (“THL”). Note that some middle market funds have grown substantially and started to expand into larger UMM deals, like THL”), which does deals as small as $250MM and as high as $2.5Bn.
- Investment philosophy: UMM funds work on transactions just below the megafund level. UMM can toe the line with some megafund PE deals as well. While UMM funds do focus on financial engineering, there are usually last-mile operational improvements that can drive returns as well.
- Lifestyle: Lifestyle can vary pending on the fund, but expect most funds to have megafund-like hours. During live deals, expect to be plugged in most of the time.
- Compensation: Most UMM funds pay first year associates $285K to $350K. ($150K base with variable bonus compensation).
- Recruiting: Most competitive. Like megafunds, UMM funds also participate in on-cycle recruiting, which means they interview candidates and give out offers ~1.5-2 years ahead of a start date. The caliber of competition for both megafunds and UMM funds are comparable, and which funds candidates target may come down to personal preference.
- Career opportunities: Similar to megafunds, getting promoted to VP at UMM funds is extremely challenging, so direct promotes are not unheard of. Still, most associates tend to follow similar exit paths as their megafund peers (top 3 MBA, different PE fund, portfolio company, business, or startup.)
- Overview: Funds that acquire companies with $200 Million to $500 Million of enterprise value.
- Investment philosophy: MM PE funds are very different from UMM and Megafunds. The companies they work with are much smaller and usually has room for many operational improvements and add-on acquisitions. It is not uncommon for these PE associates to take board observer seats or fly to portfolio companies every now and then to work on an initiative with the management team, such as financial reporting or add-on acquisitions.
- Lifestyle: Lifestyle tends to be better than Megafunds and UMM funds, though you should still expect to work 60-70 hours a week most of the time. Of course, during live deals, all hours go out the window and associates enter the “deal bunker” just like their megafund peers. However, deals usually close quicker and are less complex, so time spent in the bunker might not be as long.
- Compensation: Most MM funds pay first year associates $200K to $250K.
- Recruiting: Very competitive. Most middle market funds do not participate in on-cycle recruiting. They wait for banking analysts and consultants to gain 1-2 years of deal experience, with a more immediate start date or start date 1-year out. Middle market PE firms hire from a variety of banks, though relevant middle market deal experience at a bank like William Blair, Houlihan Lokey, or Raymond James might prepare you better for this role than bulge bracket experience. Middle market PE funds tend to hire only bankers and not consultants.
- Career opportunities: MM PE Associates may follow the same path as UMM and megafund associates, often going to a top 5 MBA program, going to a different PE fund, portfolio company, business, or startup. However, it is easier to get promoted directly to VP at these funds (though not everyone will get there, as PE organizational structures tend to be pyramidal, with more associates than there are VP spots. VP’s have long-term carry in the fund that vests over 10 years, so they are in it for the long run. This forces associates to cycle out, which is the norm.
Lower Middle Market
- Overview: Funds that acquire companies with up to $200 Million of enterprise value. There are a long tail of funds in the LMM. Note that some funds like Audax and Incline largely started as a LMM platform but have since encroached into the middle market. Again, the line between fund segments is blurred, but should provide general guidance.
- Investment philosophy: LMM PE funds are often the first institutional capital in the companies they acquire. Because of this, there tends to be a lot of room for the professionalization of operations, such as adding an ERP system, setting a higher bar for KPI’s, making new hires, and other initiatives to make the company run more efficiently. PE associates attend board meetings and can interact weekly or bi-weekly with management teams to check in on and help with initiatives such as financial reporting, add-on acquisitions, and other strategic initiatives.
- Lifestyle: Lifestyle tends to be far better in LMM PE, though at least 60 hours a week should be expected. Culturally, do not expect NYC boardrooms or flashy suits when working in LMM, as oftentimes these companies tend to be family- or founder-owned and have different cultures than large corporations. As these funds tend to have much less headcount than larger firms, culture is extremely important.
- Compensation: Most LMM funds pay first year associates $180K to $250K.
- Recruiting: Competitive. There are simply not enough PE spots as there are qualified banking analysts and consultants (let alone unqualified individuals). However, there is a long tail of LMM funds, so there are more associate spots available. LMM funds do not participate in on-cycle recruiting. Most hire a few months before the start date after candidates have 2-3 years of experience. LMM firms have a preference for hiring from MM and LMM banks, as cultural fit and relevant transaction experience working with smaller companies is helpful to be successful.
- Career opportunities: Many LMM PE funds are upfront about the option to go partner-track for top performers. Because there are a long tail of LMM PE funds, there are more VP spots available across the board. Of course, LMM PE Associates can also do what their peers at bigger funds are doing, though the outcomes are more variable given the long tail of associates there are of variable quality. Nevertheless, LMM PE offers the most operational exposure and can be good for developing business acumen in addition to finance skills.
Private equity is not a one-size-fits-all industry. While all PE firms are in the business of acquiring companies and generating superior returns for their LP’s, the culture and day-to-day can vary widely across different funds. It is important to be thoughtful about whether or not to pursue private equity and understand what you are signing up for across the range of PE firms. Nevertheless, the learning opportunities are outstanding and sets you up for a long and successful career no matter what you decide to do in the long run.
A note on lifestyle: no one joins finance expecting to work a 9-5. Private equity is an extremely rigorous industry and requires being plugged in most of the time. In exchange for the hours, compensation is very high, and associates are able to work on buying some of the most notable companies as a 23 year old (two years out of college). The business learnings are unparalleled, and the risk-adjusted lifetime compensation is bar none. Do not pursue private equity if you are not willing to make this tradeoff.
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