Investment Banking vs. Private Equity: An Overview

Private equity and investment banking both raise capital for investing purposes, but they do so in very different ways. Private equity firms collect high-net-worth funds and look for investments in other businesses. Investment banks find businesses and then go into the capital markets looking for ways to raise money from the investment crowd.

Key Takeaways

  • Investment banks and private equity firms are both involved with placing the shares of companies into the hands of investors and facilitating M&A deals.
  • Investment banks tend to act as middle-man, marketing shares of publicly traded companies to other investors in a sell-side function.
  • Private equity firms, on the other hand, invest their own money in a buy-side fashion in privately held companies.

Investment Banking

Investment banking is a specific division of banking related to the creation of capital for other companies, governments, and other entities. Investment banks underwrite new debt and equity securities for all types of corporations; aid in the sale of securities; and help to facilitate mergers and acquisitions, reorganizations, and broker trades for both institutions and private investors. Investment banks also provide guidance to issuers regarding the issue and placement of stock. Investment banking positions include consultants, banking analysts, capital market analysts, research associates, trading specialists, and many others. Each requires its own education and skills background.

A degree in finance, economics, accounting, or mathematics is a good start for any banking career. In fact, this may be all you need for many entry-level commercial banking positions, such as a personal banker or teller. Those interested in investment banking should strongly consider pursuing a Master of Business Administration (MBA) or other professional qualifications.

Great people skills are a huge positive in any banking position. Even dedicated research analysts spend a lot of time working as part of a team or consulting clients. Some positions require more of a sales touch than others, but comfort in a professional social environment is key. Other important skills include communication skills (explaining concepts to clients or other departments) and a high degree of initiative.

Private Equity

Private equity, at its most basic, is equity (i.e. shares representing ownership) in an entity that is not publicly listed or traded. Private equity is a source of investment capital that comes from high net worth individuals and firms. These investors buy shares of private companies—or gain control of public companies with the intention of taking them private and ultimately delisting them from public stock exchanges. Large institutional investors dominate the private equity world, including pension funds and large private equity firms funded by a group of accredited investors.

Private equity is sometimes confused with venture capital because they both refer to firms that invest in companies and exit through selling their investments in equity financing, such as initial public offerings (IPOs). However, there are major differences in the way firms involved in the two types of funding conduct business.

Private equity and venture capital buy different types and sizes of companies, invest different amounts of money, and claim different percentages of equity in the companies in which they invest.

Sell-Side Versus Buy-Side

Investment bankers work on the sell-side, meaning they sell business interest to investors. Their primary clients are corporations or private companies. When a company wants to go public or is working through a merger-and-acquisition deal, it might solicit the help of an investment bank.

Conversely, private equity associates work on the buy-side. They purchase business interests on behalf of investors who have already put up the money. On some occasions, private equity firms buy controlling interests in other businesses and are directly involved in management decisions.

Regulatory Challenges

In 1933, the United States became the first and only country in the world to forcibly separate investment banking and commercial banking. For the next 66 years, investment banking activities were completely divorced from commercial banking activities, such as taking deposits and making loans. These barriers were removed with the Gramm-Leach-Bliley Act of 1999. Investment banks are still heavily regulated, most notably with proprietary trading restrictions from the Dodd-Frank Act of 2010.

Private equity, like hedge fund investing, has historically escaped most of the regulations that impact banks and publicly traded corporations. The logic behind a light regulatory hand is that most private equity investors are sophisticated and wealthy and can take care of themselves. However, Dodd-Frank gave the SEC a green light to increase its control over private equity. In 2012, the very first private equity regulatory agency was created. Particular attention has been paid to advising fees and taxation of private equity activity.

Analysis

Investment banking analysis is much more careful, abstract, and vague than private equity analysis. Part of this is explained by the compliance risks investment banks face, as painting too specific or too rosy a picture can be perceived as misleading.

Another possible explanation is that private equity associates are much more likely to have "skin in the game," so to speak. With their own capital on the line and less patient clientele, private equity analysts often dig deeper and more critically.

Culture

Colloquial tales of a private equity associate lifestyle appear to be much more forgiving and balanced than their counterparts in investment banking. The strict, suit-and-tie, 14-hour and high-stress corporate culture popularized in movies and television reflects investment banking culture.

Private equity firms are usually smaller and more selective about their employees. But once a hire is made, they care less about how performance is maintained. There are exceptions and overlaps in every industry but, in general, the average day is a bit less stressful for private equity associates.