Chicago Booth Review Podcast How to Get into Private Equity

Scott Meadow: Now you've got sector-specific expertise and you can do one of two things. You can knock on the door of Madison Dearborn and say, "I'd like to be on your operating team." Now, you're going to get carried interest for being on the operating team. You can make partner being on the operating team. And once you're in the door, anything can happen if you're talented.

Hal Weitzman: You can earn a fortune in private equity. So how do you get started in the PE world? Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking insights in a clear and straightforward way. I'm Hal Weitzman, and today I'm talking with Chicago Booth's Scott Meadow about how you can make a plan for a lucrative career as a PE professional. Scott Meadow, welcome back to the Chicago Booth Review Podcast.

Scott Meadow: Thank you. I'm glad to be here.

Hal Weitzman: We had such fun with you last time talking about venture capital, but we wanted to have you back because right at the end of that episode, you said, "Well, another alternative is private equity." So let's talk about that. What advice you give people who want to get into private equity? First of all, you told us all about the pathway, the process, your process for getting into venture capital. What's different about private equity structurally and what is it in terms of the experience they're looking for and the pathway to get in?

Scott Meadow: Well, let me provide a little context on the entrepreneurial ecosystem, if that's okay. I think that will make this easier to understand. So there's sort of four basic ways to make money under the umbrella of the entrepreneurial ecosystem. Last time we talked about being an entrepreneur and getting equity, hopefully that company's successful, you do very well. There's being a venture capitalist. You have a carried interest. You invest in portfolio companies. If those companies do well, you get a piece of the success. In the private equity world, there is the private equity investor, the KKRs, the Carlyles, the Linden Life Sciences, et cetera. And then there's the portfolio companies that those private equity firms invest in. Now, those private equity firms, we have to have a little bit of context, which many of our listeners may know, but people are looking for consistent cash flow when they invest in a private equity investment, meaning KKR is looking for consistent cash flow.

And so, let's say that a company for the last five years has done $50 million of EBITDA and the private equity firm buys that company for seven times, and that's 350 million. And then they're going to hold that company until they make roughly 2.5 times their money, and then they're going to look to sell it to somebody. So let's take the 350 times two and a half. It's roughly a billion dollars. We sell the company, we take 100 million, we pay off the debt. That leaves us with 900 million of equity. The private equity guys are going to give 9% roughly to the management team. So let's say you're working for a portfolio company of a private equity firm and you have a half a point, right? Which doesn't sound like a lot, but a half a point of 900 million is not a bad day at the office.

And so when I'm talking to my students, I had a student who was, he had a PhD in actuarial sciences, and he comes into an entrepreneurial class, "How could I ever break in?" Well, think about what private equity firms are looking for. They're looking for consistent cash flow. So they don't care really what the business is. It can be in any sector at this point. The industry is so mature and there's so many people chasing deals at this particular time. That if there's insurance assets that have been acquired, et cetera, then there's a really high likelihood that my student who has a PhD in actuarial sciences and has had a big career at Northwestern Insurance, let's say. If that person did nothing more than just move over to a company that was owned by KKR that was in the insurance business, he would be doing, or she would be doing likely the exact same job that they were doing before.

The difference would be that they would have a comparable salary and equity upside. Equity upside that is much more certain and safer than anything in the venture capital business. The likelihood of losing money on a private equity deal that a private equity firm put in is much, much lower than it would be in a venture capital deal.

Hal Weitzman: Sure. Sure.

Scott Meadow: So by being a mature, being a professional in what we would call sort of traditional industries, right, there's going to be many opportunities where you'll get paid for your experience and still allow yourself to have safety, but an equity upside.

Hal Weitzman: Okay. And it's important to be in the portfolio company.

Scott Meadow: I think the portfolio, I think of the four ways you can make money under the entrepreneurial umbrella, the fastest way to money is to have equity in a portfolio company that's owned by a private equity firm.

Hal Weitzman: One of the things that I know you and I have talked about is that getting into private equity is hard if you don't have investment banking experience, which obviously a lot of your students do. What do you say to people who don't?

Scott Meadow: Well, it's very difficult because the top private equity firms hire people out of college. They let them... Well, that's not exactly. Investment banks hire... Goldman Sachs hires you how? You go to work for Goldman Sachs. You get recruited. You work for two years for Goldman Sachs in the M&A department. KKR recruits you. You work for KKR for two years. They say, "We will rehire you after you go to business school." You go to one of four business schools and they rehire you. So it's already getting more difficult, right? So if you're not one of those people, then you try to get a job with an investment banking firm and hopefully after three or four years, you can jump on an associate position at a private equity firm, a top private equity firm, or perhaps a middle market private equity firm. But generally, they're looking for people that have been through an investment banking training program before they get hired.

But if you look at top firms like Vista Equity, which is one of the best software investors out there, they have an investing track and they have a management track, right? So think about the same thing we were talking about in our previous session. Think about a resume that says, Scott Meadow, University of Chicago Boost School of Business, Purdue University. And the first line on your job list is director of new business development for XYZ company, a Madison Dearborn portfolio company sold to Microsoft. Okay? Well, now you've got sector-specific expertise, you've worked in a cash constrained environment, you've made money for institutional investors. At that point, you're at the crossroads we talked about last time, and you can do one of two things. You can knock on the door of Madison Dearborn and say, "Geez, you've got an operating team here. I'd like to be on your operating team."

Now, your carry, you're going to get carried interest for being on the operating team. You can make partner being on the operating team. And once you're in the door, anything can happen if you're talented. And at the same time, you can go back and work for another private equity firm if that seems like something that you'd prefer to do.

Hal Weitzman: Okay. Now, last time you talked about the need to pour yourself an extremely large glass of wine and spend weeks doing research about venture capital firms. What do you do here? How do you research the private equity world?

Scott Meadow: Candidly, I would do the same thing.

Hal Weitzman: Okay. So just remind us of that process.

Scott Meadow: Yeah. So let's say that I'm a person who went to Ohio State, went to Chicago Booth and has been working at Humana for the past three years. I'm 27 years old. I got another year and a half to go in the part-time program, right? So what should I be doing right now? Well, probably the largest sector in the venture capital industry is healthcare services as an example. So our hero is basically going to pour himself a glass of wine and in column one, he's going to write down top private equity firms that invest in healthcare services. And there's usual suspects. There's Welsh, Carson, Anderson, & Stowe, there's Fraser and Company, there's Linden Life Sciences here in town. And so what you're doing while you're kind of going through your time in the academy is you're sort of expanding your understanding of who are the investors in healthcare services.

So maybe you've got a list of 15 or 20 private equity firms that are investing in healthcare services, similar process. Let me talk about it again. You pour yourself a glass of wine, you get on Welsh, Carson's website and you say, "Okay, well, what do the associates look like that are there? What do the associates on the operating team look like that are there?" And then you start looking at the portfolio companies. And the portfolio companies, and you're narrowing them down based on two criteria. Can I add value? And most importantly, because I don't want to live an affluent life of quiet desperation, am I super excited about working for this company? And at that point, it's much easier when you think about it because column two is substantial companies that are owned by these private equity firms or else they wouldn't be owned.

If they're not substantial and safe, i.e., generating cash flow that we would bet our firstborn child is going to actually occur, they would have never purchased these companies to begin with. So safety first, right? So now you've got a list of, let's say, 15, 20 of these companies. Now it's especially important to really get to know the CEOs and figure out which ones are going to provide you with the kind of environment that'll allow you to learn how to be an entrepreneur. And then you're ultimately just applying for a job and you're a pretty fancy candidate at that point, right? My subject had been working at Humana. He probably had P&L responsibility on some level, right? He's got the Booth MBA, right?

And all you're doing is being hired into theoretically what is another big company. It just happens to be owned by a private equity firm, which means you're going to have an equity upside opportunity. And even if you don't, you at least get it on your resume. So the next time after the liquidity event, you get hired by another private equity portfolio company, and this time you have-

Hal Weitzman: So you can actually work in private equity without working in private equity. You work for a series of portfolio companies.

Scott Meadow: The goal is making money. And the fastest way to make money and the safest way to make money in the entrepreneurial ecosystem is to work for a portfolio company that's owned by a private equity firm.

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Scott, in the first half, we talked about the world of private equity and how to get into it. And one of the things you said, which I wanted to press into a little bit more, is you said, look for a portfolio company, perhaps it's owned by a good, well-resourced, well-known private equity company. How do you assess what ticks those boxes?

Scott Meadow: Well, I think it's multiple funds that you've seen over time, right? So there might be a nice fund that's put together $100 million and so forth. But if you're going to join one of their portfolio companies, then we have no confidence that they're not going to run out of money at some point. Now, getting a job in the venture capital business, you can't get a job in the venture capital business unless you have a job in the venture capital business. So you may decide to take a job with a first time fund if you can get hired as an investor, but looking for a portfolio company where you can get sector-specific expertise in a cash constrained environment, it would probably be better if you could look for the absolute best funds, because they're going to have access to probably the best deals first, and they have a long history of raising money and having that money available to fund projects. So you can be more secure that they're going to be there when the portfolio company that you're working for requires money than a first time fund.

Hal Weitzman: But how do you actually vet them?

Scott Meadow: You could just look up who their limited partners are. That's another thing, by the way, not only... They'll say, and I think most of our audience will know, they'll say, "This is Hal and Scott Fund 2," right? Which would not be as good as Hal and Scott Fund 6, right? So that's one way. The other way is the same system that we're using in picking portfolio companies. Who are the LPs, the limited partners? So there's four different... There's multiple kinds of LPs. There's pension funds, CalPERS, CalSTRS, there's university endowments, University of Notre Dame, Yale University, there's wealthy individuals, the Pritzker family, and their sovereign wealth funds. So if you see that the top LPs are supporting a particular fund, chances are those guys are always going to be in business. So if the portfolio company that you're working with is performing, chances are that that GP is not going to pull the plug.

Hal Weitzman: All right. So big LP is a good sign?

Scott Meadow: It's another sign. Yeah.

Hal Weitzman: Okay. All right, excellent. Now, this is all getting you in, but once you're in, as you said in the first half, you've got to be happy as well. You can't be miserable. And one thing that makes people happy is kind of just the environment, the environment of mentorship or learning or anything else. How do you vet that part?

Scott Meadow: Well, if you think about the process you went through in terms of getting a job with the portfolio companies, you've done a lot of work on the company yourself. If I'm enjoying what I'm doing, it's been my experience that I'll be pretty nice in the sandbox. How are you successful? You've got to be analytically gifted, you got to be professional, show up on time, and you got to play nice in the sandbox. But playing nice in the sandbox is often a function of whether or not you're excited, et cetera. And I like to think that if I've narrowed down the opportunities in such a way so that it custom fits the interest that Hal has, then chances are I'm going to make it work. Even if the CEO is probably not somebody I'm going to invite to my birthday party for whatever reason, I can still learn from that individual and enjoy what I'm doing.

Hal Weitzman: And you're developing that deep expertise, what you're doing.

Scott Meadow: And you're developing sector specific expertise while you're doing it. I think where you have a harder time is when you join as an investor, right? When you join a firm for the first time, you really don't have a lot of flexibility. It's so hard to get a job, particularly if you don't have any prior work experience in a cash-constrained environment, that you're generally going to have to take whatever you get. And the bigger the firm, the more pointy it is at the top. And needless to say, you're not at the top, you're at the bottom. So there's lots of politics in that situation and less politics, I think, in the venture capital business than in the private equity business. But there's still politics, there's still a tremendous ego on the investing side, and you just have to be ready for that going in.

Once you're in the business for three or four years, you can begin to have more flexibility about, "These people are not my cup of tea. I'm going to see if I can find a culture that better fits my personality."

Hal Weitzman: Scott, you said that ultimately it's all about money. It's all about earning money, which is why people get into these worlds. So tell us, as much as you know, much as you can shed light on it, what are we talking about in terms of compensation across various roles in private equity?

Scott Meadow: Well, I think we got to go back to the kind of firm it is, right? And I think one of the things I always say in class is, would you rather have 80% of a cupcake or 10% of a wedding cake, right? Obviously, 10% of the wedding cake, because it's more cake in mouth. And I think you have to think about your compensation in a similar fashion. So there may be firms where, for example, if I got hired as a 28-year-old person out of Booth to go work for Kleiner Perkins, maybe I wouldn't have a carry. Maybe I would, but maybe I wouldn't. But the chance of being at Kleiner Perkins and then getting a carry on the second fund after I've proven that I can actually perform is actually going to deliver more money to me over the long term than if I had joined Heckel Jekyll and Schmeckel Venture Fund and had a 10% carry.

So I think it depends on the stature of the firm. And I think if you have any kind of carry in your first fund, that's a positive. But the way I think about compensation is if the fund is doubled and we pay back the LPs, how much money will I, Scott Meadow, make? And if that feels like an appropriate number, one way of thinking about that, if by the grace of God, somebody got that job and they were able to, at the end of a fund, pay off their loans from Booth and maybe have a down payment on a house from a lifecycle standpoint. That would be a terrific place to be at, let's say, three years out of business school.

Hal Weitzman: That sounds good. Yeah. That makes me think about the other thing I wanted to ask you about, which is when to get out, exiting, the timing of exiting and sort of you get these milestones, don't you, where there's value created or there's a sale. When is a good time to kind of jump ship and-

Scott Meadow: Well, I'd have to suggest first and foremost that everybody takes my class Commercializing Innovation where we'll study more about that. But truth be told on the venture side of the world, what are the people that provide liquidity looking for? What is Wall Street looking for? What is a corporate acquirer looking for? They're not looking for the company necessarily to be making money, right? Let's say we were taking a company that we've all heard of public like Staples. Well, Staples, when that went public, I think there were eight units that were opening and the company was losing money at the corporate level, but nobody looked at the corporate level because everybody was focused on the unit level. Were the stores performing in a way that they were drawn up back at the office?

And so, that's the thing that's most important, is are we demonstrating proof of concept, whatever that means. And if we're demonstrating proof of concept, then we can begin to think about liquidity or raising money at a much higher price because the risk is a lot different on execution as opposed to whether or not this is different than the legacy solution.

Hal Weitzman: Right. Okay. Well, Scott, unfortunately... This is a great discussion.

Scott Meadow: Thank you.

Hal Weitzman: Unfortunately, our time is up.

Scott Meadow: Okay.

Hal Weitzman: So thank you very much for coming and telling us how to get into and perhaps out of private equity.

Scott Meadow: Well, I'm always available. Thank you so much, Hal.

Hal Weitzman: Appreciate the discussion.

That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website, chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research. This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.