The Holy Trios of High Finance

Hedge Fund, Private Equity and Venture Capital

Hedge Funds, Private Equity, and Venture Capital are what I call the “Holy Trios of Finance” because they are long-term destinations for finance people. I get enough questions about moving across these there paths that I should try my best to describe the three paths in detail. I will cover areas such as entry point, day-to-day on the job, career progression path, compensation, the pros and cons.

The Holy Trios are investing roles, despite not having the word investing in their names. Their primary task is to make more money using clients’ money. With great responsibility comes great power – they are the first-class citizen in the finance world with the highest compensation upside and are served by the professions you salivate for – namely, Investment Banking (IB), Management Consulting, Equity Research (ER), etc.¹

Conversely, with great power comes great responsibility - you need to know what you are doing. Compared to making pitch decks in investment banking or writing earnings notes in sell-side research, your work for a hedge fund, private equity, or venture capital can mean millions or even billions of client money being put to work.

The Holy Trio does not usually hire straight out of college, because they can source talents from the sell side where the foundational skills are taught. There are exceptions, but most of us are not that wunderkind from Yale who got into Blackstone straight out of undergraduate.

So keep reading.

What Is Private Equity

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Private equity firms invest in private businesses or turn public businesses private.

Most PE firms engage primarily in leveraged buy-out (LBO), a fancy technical term that describes buying a whole business using mostly debt. The idea is very simple, it works the same way as buying a house or a car with loan. Over time, your ownership, or equity, in the car or house increases as you pay off the loan. Same works for leveraged buy-out, but of course owning a business is more complicated.

PE investors are truly long-term (not your typical “private equity approach to the public market” type hedge funds with a 500% annual portfolio turnover-type): They have a 3-7 year holding period.

They focus on operational improvement to make sure there is enough cash flow to service the heavy debt load. Diligence is very deep because you have all the information that is not available to the public investors and you can decide how to run the business. However, you cannot change how the external competition and macro environment impact the business. So it’s still far from a sure thing in making money.

Entry points

• Investment Banking: the most typical feeder profession for PE

• Direct from undergraduate: really reserved for a very limited number of top undergraduate schools – I presume Ivy League

• Management Consulting: Without transaction experience gained from doing IB, the risk is you could be pigeonholed into an operational role at a portfolio company instead of the traditional PE associate path.

• NOT MBA: It’s nearly impossible to break into a traditional private equity role without IB experience. Even if you pursue an MBA, you will need to work as an IB associate before getting looks from PE firms.

Day-to-day

• Modeling (LBO)

• Research / diligence (management, industry, experts, etc.)

• Write investment memos, prepare materials for the investment committee

• Support portfolio companies

  • FP&A, board meetings, management meetings, day-to-day business operation, follow-on financing needs

• Hours are 65 hours on average. Can converge to IB hour during live deals. Still overall better than IB, but if you compare it to insanity, anything is better.

Org structure

• Associates: They are the doers - modeling, PowerPoint, and writing (you thought you are done with that after IB)

• VP: They transition from doer to a project manager. Managing the deal by leading conference calls with the company, consultants, lawyers, and any other parties involved in the deal process to make progress.

• Director / Principal: They are more removed from the deal process and more involved in deal sourcing.

• Partner: They are relationship folks who have paid their dues. They are mostly sourcing private companies to buy by talking to owners. They also represent the PE firm in fundraising and industry conferences. A textbook example on steroid at this ranking would be David Rubinstein of Carlyle.

• Operating partners: They usually have C-suite or management consulting experience. I am not going into details but they are deployed to portfolio companies to drive change and value (cutting cost will be one way, of course, we all know that)

Compensation

• Very structured and stable, but it varies across fund sizes. So I will exaggerate by using mega PE firms (the likes of Blackstone, KKR, and Carlyle) as an example. Based on the 2022 Heidrick & Struggles survey:

  • Average Base + Bonus on 2021

    • Associate: ~$350,000

    • VP: ~$750,000

    • Principal: ~$1,000,000

    • Partner: ~$2,000,000

• That’s not even where the real action is at. In private equity, a big variable compensation piece is the carried interest, which is a share-in of the performance fee when a private equity fund achieves its promised return hurdle.

  • VP and above ranks start getting carries. Of course, the carry % increases as you move up the ranks. It’s probably very volatile. Citing the 2022 Heidrick & Struggles survey again: A VP, Principal, and a partner can get millions or even tens of millions in a year (in this case, an average of $6,500,000, $16,000,000 and $50,000,000 for VP, Principal and Partner, respectively), completely dwarfing what they make on base and bonus

  • Venture capital compensation works in a very similar way, as we will see shortly

Good and bad

• Good: Deep research; Long-term; Learn about operations; Good exit opportunities because of the combination of financial and operational skills. 

• Bad:

  • Still very long hour

  • Takes time to progress to the senior level

  • No matter what subgenre of PE, you will be looking at slow and steady but unsexy businesses

“Grass is Greener”

Some PE professionals want to work in a hedge fund because:

• Pure focus on identifying investment ideas without dealing with the process work

• Better hour

• Compensation upside is higher and quicker career progression

The trade-off:

• Hedge Fund is much less stable. You can make $0 bonus in a year, or worse, very topical right now – hedge funds are shutting down left and right, depending on the strategy.

• You are never off: Hour is better, but no one becomes a better investor by just working 60 hours a week. You will never be off at a hedge fund. Hedge fund is just long hour but condensed, driving burnout in a similar fashion just like how long hour drives burnout at PE.

• Secularly declining: A critical vector in compensation upside is the growth in AUM. It’s a rhetorical question: when is the last time you heard a hedge fundraise billions? Hedge funds and the broader public investment management industry are secularly challenged. As an investor, I like to invest in where the tailwind is – the hedge fund’s glorious 2/20 days are long behind us.

What Is Hedge Fund?

Most of you know hedge funds invest in stocks and bonds, but there are other assets they invest in such as currency or commodities futures. There is also an emerging business model called crossover funds that invest in both public and private assets.

I will use a single-manager long/short hedge fund as an example. If you are interested in learning about the other styles, please read this article. 

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Entry points

• Most typical paths are from investment banking and sell-side equity research

• There are some PE professionals who want to move to hedge funds and their background is heavily favored by some of the most elite hedge funds in the world such as a Tiger Cub.

• Management consulting can be a decent background to get into a hedge fund too. Maverick Capital, which is a Tiger Cub, is vocal about its receptiveness to hiring McKinsey consultants.

• Other than that, I think you can easily overcome your lack of relevant experience by proving you have tangible research skills via actionable stock ideas. The point is, if you work in big 4 consulting or in corporate finance or some less relevant roles, there is no better way of proving you have the passion and skills for the job than showing it via tangible work products.

Org Structure and Day-to-day

Hedge funds have a flat hierarchy.

• As a Research analyst:

  • Typically you have no idea generation responsibility. Your Portfolio Manager or Senior Analyst will give you ideas to look at. If you have ideas that you think fit your firm’s style, by all means, pitch it to them and see how they respond.

  • The goal of your day-to-day centers around forming a view on whether the stocks you are looking at are a buy, a short, or a pass. So your day-to-day is to read, do financial modeling, and talk to people – expert networks, sell-side analysts, company investor relations, company management, industry contacts, etc.

  • In this profession, you are not going to be given a lot of directions, which is good or bad depending on how you work

    • The typical instruction would be “Hey, Richard, take a look at this company, let’s catch up later this week to talk about what you think.” That’s all. And that’s why they don’t hire straight out of college because you are expected to have baseline skills and a process to get to a conclusion without much guidance

  • And then there is maintenance work: over time, hopefully, your PM will buy or short stocks you have worked on. You will be responsible for following news and big movements for those stocks and providing timely updates on the thesis to your PM.

• Senior Analyst:

  • They research stocks too but can delegate some of the data gathering and analytics to the junior analyst

  • They are more focused on generating ideas and pitching them to the PM

• Finally, Portfolio Manager

  • All stock-picking funds’ Portfolio Managers started as an analyst, so they could be working on ideas too if they choose

  • The PM listens to idea pitches from her team and decides whether and how much capital is put behind those ideas.

  • She is also responsible for risk control: position sizing, deciding on net exposure, factor risk, and how is the portfolio positioned for her view on the macro outlook

  • She represents the firm in fundraising and also manages the non-investment people as well – CFO/COO, head of IR, etc.

Compensation

There is no standardization: The biggest mistake I see people make is to decide on offers based on which fund pays a higher BASE salary or even compare it against investment banking compensation which has a much worse lifestyle and less comp upside. Just know your base salary won’t increase dramatically even at established funds as you progress.

For base pay: At a decent sized fund, $150k for a research analyst, $200-250k for a senior analyst, no idea for Portfolio Manager and I am sure they couldn’t care less

The bonus is where the action is at.

• The sad reality is a single-manager hedge fund is not a true meritocracy. Your bonus is still at the mercy of the generosity of the founder

• Research analysts are paid a discretionary bonus, decided by the PM. In a good year, making $300-400k all-in is not unheard of.

• Senior Analyst’s bonuses can be tied to the fund’s overall profit, not % of their contribution. I have heard numbers ranging from 3-5% of the firm’s incentive fee.

• Let me give you an example of a $1 million all-in comp year for a Senior Analyst. Assume a $1 billion AUM fund with a 2/20 fee structure and the fund generates a 10% return for the year. That means $100 million of value creation to the LPs, for which the fund makes a 20% performance fee, resulting in a bonus pool of $20 million.

• Assume the Senior Analyst gets 4% share of the bonus pool, which will be $800,000 bonus. Adding the $250k base gives an all-in comp of just over a $1 million. Before the tax man gets involved of course.

• The Portfolio Manager keeps the rest.

• Two factors impact hedge fund bonuses:

  • Asset under management per IP (investment professional)

  • Fund performance

• The quality of PM is critical for both vectors and most PMs are only good at one of the two – most are either good at making money or good at raising money but not at both.

Exit opportunity

• Hedge fund investors can exit many paths as long as you network and pitch their experience right. Typical exits I have heard are: entrepreneurship / venture capital, corporate strategy, going back to sell-side, LP side (allocator, endowment, pension fund), investor relations

Good / bad

• Good: 60 hours a week on the job – decent hours (also a con, keep reading). Highest compensation upside and quickest path to progression for those who perform

• Con: very stressful, no stability (can have 0 bonus years and worse - the fund can go out of business and you will be out of a job).

  • 60 hours is kind of an illusion. To become a great investor, depends on your intelligence, you need to put in more hours, so you are never really unplugged from trying to generate another idea or learning about another business model, or finding another trade setup.

  • Public equity investing is secularly declining. Most of the institutional investor money is flowing into private equity or venture capital or whatever is not invented yet

Grass is greener

• Getting into venture capital: First, you should be covering high-growth sectors to have a shot. You can try to land a public equity role at a crossover fund and see if you can network into the private side. Or you can just network into a VC fund. I know people who have done it.

• Getting into private equity will be very difficult without IB experience because you lack the transactional knowledge that is beyond just researching the business or making a call on valuation. You can network into IB and try PE after doing IB for a few years. Or you can try an MBA and then do IB associate and try PE after a few years.

What is Venture Capital?

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Venture capitalist is a form of private investing. They invest in start-ups by providing capital and advice.

Venture capitalist follows the power law: a very small number of successful investments will be responsible for most of the return for a venture fund.

Raising VC money for your start-up can be a seal of approval and a big milestone, but in exchange you have to give up ownership in your creation. Those of you who have watched Shark Tank know how this works.

Entry Points

• Entrepreneurship: because there is no better to prove you have the experience to assess whether a start-up and the founder can achieve success

• Investment banking, management consultants: because you sold your souls for exit opportunities so you deserve a shot at every high-profile career, which includes VC

• “Product people”: Product Manager or Engineers, they have the right skills to know whether a product can solve a problem or know ways to fix a product

• I have seen sell-side equity research people covering the growth sector get a shot in VC

• MBA: cuz you paid for the optionality, but it’s very predicated on your pre-MBA work experience and how you approach recruiting during MBA.

One big difference between VC and the other two members of the Holy Trios is the Tier 1 VC firms have consistently generated the majority of the returns of the entire industry.

The reason is VC investing is very relationship driven and start-up founders want guidance from John Doerr (Kleiner Perkins), Doug Leone (Sequoia) or Bill Gurley (Benchmark) of the world, so the winner tends to keep winning. The implication for you is if you are dead set on only working for Sequoia, Kleiner Perkins, or a16z, you can’t just bring your A game, but your triple-A game because it’s going to be insanely competitive.

Day-to-Day

• Reviewing start-up pitch decks, number crunching, and writing investment memos

• Support portfolio companies

• Source investment opportunities

• Fundraising

Org Structure

• Analysts and associates: they crunch numbers, analyze companies, write investment memos, look at pitch decks, and basically do anything their seniors don’t want to do

• Principals: they still perform diligence, but they are more involved in sourcing investment opportunities by building and leveraging their networks to meet entrepreneurs and start-ups under these buzzwords and also they are very “hands-on” in supporting their portfolio companies

• Partners: Most senior people. They have the final say on whether to make an investment and have a big stake in the VC funds so they share both the upside and downside. They are also involved in fundraising. Every VC firm has a managing partner who oversees the strategic direction of the firm itself. For Sequoia, Roelof (Botha) is that figure.

Compensation (base + bonus)

• Analyst, $100k

• Associate / Senior Associate: $150-250k

• Principal: $250-400k

• Junior Partner: $400-600k

• Partners: $500 – millions

Similar dynamic to a private equity firm, the action is really in the carry and that depends on firm size and fund success. I don’t have the actual numbers but use your imagination. Let me try to paint you a picture by mentioning some big dawgs in the space:

• Doug Leone is worth $6 billion, he invested in ServiceNow.

• Bill Gurley is worth $8 billion, he did Service A in Uber.

• John Doerr is worth $13 billion, if you didn’t know, John invested in Amazon and Google, no big deal.

Pros

• Unlike private equity, everything you will look at in VC is by definition sexy. You get to learn about products and businesses that try to solve the biggest problems of the future (insert clip).

• VC is very suitable for the social butterfly type because you must be networking constantly to find the next Zuckerberg or SBF and bet them to take your money instead of your competitor VC’s money. And of course, you won’t know whether they are Zuck or SBF until afterward.

• Decent work-life balance.

• Similar to private equity, VC is not secularly challenged because it’s very relationship-driven, and especially the Tier 1 VCs have consistently created value for their investors. So it’s at risk of being disrupted by robots.

Cons

• Similar to at a hedge fund, you will always be on: People will constantly hunt you down to pitch you their start-up or ask for an intro to the partners

• Venture capital is fun but it’s still a big risk-taking job. Very topically, we just saw Sequoia and Temasek taking huge L on the FTX investments. Doesn’t feel great to blow $150 million and 250 million, does it?

• Exit opportunities are limited, especially if you have never done investment banking or private equity

• It takes a long time for your big payday, the carry, because venture investments take 7-10 years to play out, if it works out via IPO or getting sold to a big tech firm like Microsoft or Salesforce, or Meta, it’s always one of those. So you need to 1. Make the right investment 2. Wait

Grass is Greener

• If you want to move to HF or PE, I hope you have done investment banking because you are going into a more fundamental-focused style. And hedge funds and private equity firms are looking for someone with financial analysis skills, not some napkin math or finger-in-the-air analysis.

• Going into an HF: I don’t know anyone who has made that move or why.

  • If you have done IB, it’s doable. You will need to network and then prove you can do the job. Dealing with the minute-by-minute “mark to market” will be something new to you

  • Hedge Fund is much less stable and is secularly declining, especially single-manager style

• Going to private equity:

  • If you currently do VC, you probably don’t want to do LBO anyways. So you need to rely on your IB experience to network into a growth PE investment style. The drawback will be longer hours, dealing with the processes, and other negatives associated with private equity.

Thanks for reading. I will talk to you next time

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1. For my non-finance audience, The Holy Trios are also called the “buy-side”. The professions that serve them are called “sell-side.”