How do private equity firms really make money? Management fees may shed light on why PE investors have such high salaries, no matter whether the PE firm has successfully exited an investment. But how is it that some private equitytitans, like Henry Kravis of KKR andStephen Schwarzman of Blackstone, can make a windfall half-billion dollars in a single year?
To understand how private equity firms really make money, you have to understand how the returnsdistribution waterfall works. The typical split in profits between LPs and GP is 80 / 20. That means, the LP gets distributed 80% of the profits on an exit (after returning their initial capital) and the GP keeps 20% of the profits. This 20% is known as “carried interest,” or “carry.” The carry is then split up between the PE firm’s investment professionals, with most of the distributions going to the partners, while the LPs then divvy up the 80% they received based on their proportional contribution to the fund.
Now typically, a GP will only commit 1-5% of the capital of the fund; my firm contributed about 10%, which was extraordinarily high by industry standards. So think about it: the GP contributes 1-5% of the fund (or perhaps 10% at the extreme), but they get to keep 20% of the profits. That’s how private equity firmsare able to reap such enormous returns.
Let’s walk through a quick example. Say a PE firm called Awesome Capital Partners raises a $1B fund, with $950M coming from LPs and $50M coming from the GP (that’s 5% contribution from the GP). The GP theninvests all the capital in acquiring companies. A few years down the road, they exit all their portfolio companies for $2B total. The LPs get $1B back first — that’s returning their capital. That leaves $1B left, and it’s divided up 80 / 20 between LPs and GP. So the LPs get $800M and the GP gets $200M. So the GP invested $50M at the start, but gets back $200M in profits — already a 4x return, gangbusters by any standard you could apply in PE.
But there’s more. The GP doesn’t divide that pot evenly. The senior partners collect the vast majority of the profits, so if the firm only has 10 investment professionals, 4 of which are partners, and only 2 of which are senior partners, you could see how $150M in profits to the GP can quickly become a big payday for the senior partners of the firm, especially if half or more go to 2 senior partners alone. That’s just an example of a firm that raised $1B. But what about when a firm, like TPG, has more than $50B under management? They certainly have a bigger staff of investment professionals, but it’s not anywhere near 50x bigger than the $1B fund.
You see where this is going. The more AuM there is relative to the number of partners at the firm, the bigger the payday on an exit year — assuming the investments didn’t go bankrupt!
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FAQs
Private equity firms make money through carried interest, management fees, and dividend recaps. Carried interest: This is the profit paid to a fund's general partners (GP).
Where does private equity get their money? ›
A source of investment capital, private equity comes from firms that buy stakes in private companies or take control of public companies with plans to take them private and delist them from stock exchanges. Private equity can also come from high-net-worth individuals eager to see outsized returns.
Why is private equity so lucrative? ›
But the fundamental reason for private equity's success is the strategy of buying to sell—one rarely employed by public companies, which, in pursuit of synergies, usually buy to keep.
How are private equity firms compensated? ›
Private equity firms are paid based on how much profit they can generate from their investments. They are given a portion of this profit, which is known as “carry”. The thing is, most associates don't get carry. At mega funds, it's essentially unheard of, and even at sub $1B funds, fewer than 1/5 of people get carry.
How much does the CEO of a private equity firm make? ›
How much does a Private Equity Ceo make? As of Apr 12, 2024, the average annual pay for a Private Equity Ceo in the United States is $82,146 a year. Just in case you need a simple salary calculator, that works out to be approximately $39.49 an hour. This is the equivalent of $1,579/week or $6,845/month.
Is BlackRock a private equity firm? ›
Private equity is a core pillar of BlackRock's alternatives platform. BlackRock's Private Equity teams manage USD$41.9 billion in capital commitments across direct, primary, secondary and co-investments.
Is private equity oversaturated? ›
Another major downside is that private equity is a much more saturated market today than in previous decades. There's too much capital chasing too few high-quality companies, which means that returns will almost certainly decrease in the future.
How long do people stay in private equity? ›
The Private Equity Career Path
| Position Title | Typical Age Range | Time for Promotion to Next Level |
|---|
| Associate | 24-28 | 2-3 years |
| Senior Associate | 26-32 | 2-3 years |
| Vice President (VP) | 30-35 | 3-4 years |
| Director or Principal | 33-39 | 3-4 years |
2 more rows1 Funds that rely on an Accredited Investor standard generally require a minimum net worth of $1 million for an individual (excluding primary residence), and $5 million for an entity. for an individual, and $25 million for an entity.
How do PE firms use debt? ›
When a private equity firm recapitalizes a company, they often use debt financing to finance part of the acquisition price – we have written about this here. In addition, private equity firms often ask owners of the companies they buy to “roll over” or reinvest part of their equity into the new company going forward.
The firm has a history of buying up struggling companies and then loading them up with debt. This often leads to the companies being unable to meet their financial obligations and eventually declare bankruptcy. Blackstone Group is another large private equity firm, with over $300 billion in assets under management.
What is the main disadvantage of private equity investment? ›
Higher risk: Private equity investments often involve significant risks, including the potential loss of your entire investment, which must be part of the individual investors' consideration process.
How much does a VP make in private equity? ›
Private Equity Vice President Salary in California. $113,500 is the 25th percentile. Salaries below this are outliers. $187,500 is the 75th percentile.
Do small PE firms pay well? ›
The “all-in” combined salary is approximately $275k to $390k at top PE firms, but this figure can be much lower for smaller-sized funds and exceed $400k for firms with reputations for being the highest-paying (e.g. Apollo Global).
Who raises money for private equity firms? ›
Potential investors include public and private pension funds, corporations, high net worth individuals and family offices, endowments, foundations, and insurance companies. Different categories of investors have distinct advantages and disadvantages as investors in different types of private equity funds.
Can you make a lot of money in private equity? ›
Carried interest can be very lucrative because the Partners at the PE firm might contribute only 1-5% of the fund's capital, but if it performs above the hurdle rate, they can claim 20% of the fund's profits. Of course, it can easily go the other way as well.
Do people who work in private equity make a lot of money? ›
For the vast majority of first-year private equity associates, the base salary is around $135k to $155k. Then, based on fund performance, bonuses tend to range from 100% to 150% of the base salary.
How much does a private equity firm make? ›
The Private Equity Career Path
| Position Title | Typical Age Range | Base Salary + Bonus (USD) |
|---|
| Associate | 24-28 | $150-$300K |
| Senior Associate | 26-32 | $250-$400K |
| Vice President (VP) | 30-35 | $350-$500K |
| Director or Principal | 33-39 | $500-$800K |
2 more rowsOne way is to sell the company at a profit after making improvements to its operations. Another way is to take the company public, which can generate a large capital gain for the private equity firm. Some of the world's richest people have made their fortunes through private equity.
