Private Equity vs Investment Banking: What’s the Difference?

Private equity caters to institutions and accredited investors, offering them alternative investment prospects within the private sector. Conversely, investment banking specializes in preparing substantial financial deals, primarily for corporations and governments.

Private equity firms and investment banks are financial organizations that play a significant role in capital markets. The differences between private equity and investment banking are, at times, quite intricate as each one involves raising capital for investment purposes, but the overarching contrast is that the two organizations serve different kinds of clients for different kinds of investments.

Broadly speaking, private equity serves institutions and accredited investors with alternative investment opportunities in the private sector. Investment banking, on the other hand, facilitates large-scale financial agreements for corporations, governments, and other entities.

There are some important differences when understanding private equity and investment banking. This article will dive into each financial service in depth before comparing and contrasting the key characteristics and the functions that they serve in global capital markets.

Key takeaways

• Private equity specializes in private sector investments, aiming to generate long-term returns for liquidity providers
• Investment banking offers a range of financial services, including underwriting, the sale of securities, advisory services for mergers and acquisitions, and brokering large deals
• A major difference between private equity and investment banking is that private equity operates on the buy-side of capital markets while investment banking operates on the sell-side
• Another key difference is that private equity firms typically operate in the private sector, while investment banking can serve all kinds of clients and plays an important role in the process of taking companies public

Understanding private equity

Private equity is a form of investment relationship where institutional and accredited investors gain a stake in companies that are typically not listed on the public stock exchange.

The aim of private equity is to generate outsized returns when compared with public investment markets. To do this, some PE firms invest actively by restructuring portfolio companies and providing them with operational support. Other firms, meanwhile, invest passively with capital in a bid to unlock profit potential and help bring companies to scale.

As an alternative investment class, which broadly means a type of investment that is not available to the public, investors are often required to stake high amounts of capital to gain exposure to companies in the portfolio. The financial barriers to entry necessitate that most private equity investors are either institutions or high-net-worth individuals. In short, investors are able to contribute capital to a managed fund and then gain a share of profits over time.

Largest global private equity companies between 2018 and 2023, by fundraising capacity. Source: Statista

A key difference between private equity and other alternative investment classes, such as venture capital, is that private equity firms specialize in acquiring companies at later stages in their development. The core aim of private equity is to provide capital, personnel, industry connections, and other key contributions that can directly help to raise the value of a portfolio company. If the private company successfully grows, then PE firms will seek to cash-in on their investment by selling or redistributing their stake several years down the line.

Understanding investment banking

Investment banks play a pivotal role in capital markets by underwriting complex financial agreements for corporations, governments, and large-scale organizations. Unlike commercial banks, investment banks typically employ experts from across the financial markets and are able to evaluate and facilitate a variety of investment activities, including advice for high-net-worth private banking clients.

Underwriting, a key investment banking service, involves the creation of equity and debt securities, such as public stocks. In this sense, investment banks intermediate the process of going public for corporations and are integral in distributing securities to the open market for the purpose of raising funds.

Investment banks also leverage in-house expertise to provide a range of advisory services to clients. For example, institutional investors may seek aid from an investment bank to discover the true valuation of a specific company as well as how to structure a deal for a merger or acquisition. Investment banks also offer advice on exit strategies and can utilize industry connections to broker large-scale financial deals.

Leading banks worldwide in 2023, by revenue from investment banking. Source: Statista

Investment banks can act as intermediaries between regulators, corporations, and investors. They can provide strategic financial advice to clients and aid in the process of forming investment agreements in a variety of contexts. Ultimately, investment banks provide significant contributions to the functioning and efficiency of global financial markets.

Private equity vs investment banking: What are the key differences?

Both private equity and investment banking facilitate complex financial agreements on behalf of clients, connecting investors with companies in the process and vice versa. However, there are some key differences between the financial organizations and the nature of the agreements they typically execute.

Firstly, private equity usually acquire private companies in a bid to generate investment returns over time. One of the primary functions of investment banks, meanwhile, is underwriting securities agreements that can take companies public.

Secondly, underwriting services offered by investment banks revolve around creating and distributing equity securities, while private equity revolves around distributing capital to companies in exchange for equity. In this sense, private equity operates on the buy-side of the investment agreement, while investment banks operate on the sell-side.

Other key differences between private equity and investment banking

Investment banking offers a comprehensive suite of financial services in capital markets. As a result, the business model itself is very different from private equity where firms specialize in raising funds from accredited investors before generating a profit from portfolio companies over the long term.

Private equity associates often invest their own capital into a fund, which can provide a skin-in-the-game dynamic that differs from investment banking. Investment bankers, meanwhile, are often required to complete long hours in a high-stress work environment. Private equity associates would usually be required to complete a minimum of 2 years’ work experience at an investment bank before being considered for the role.

What is the overlap between private equity and investment banking?

While private equity and investment banking serve distinct purposes in capital markets, they share some similarities as well. Both private equity firms and investment banks are specialists in deal execution, despite the differences in the nature of these deals.

Both private equity associates and investment bankers also have strong financial acumen. Proven internal processes and advanced financial analytics help to provide actionable advisory services to clients, and the personnel utilizing these tools are on the bleeding edge of investment trends as a result.

Another similarity is that both organizations are able to provide accurate valuations, whether for companies in mergers and acquisitions or for securities in a public offering. Financial modeling is used across each organization to aid in the process of establishing a valuation, as well as to determine the performance of companies and the viability of new investments.

The bottom line

Private equity and investment banking both facilitate large-scale financial agreements between companies and investors. However, the way that each organization collaborates with its clients differs greatly, and there are some key differences in the way that each organization manages day-to-day operations.

Primarily, private equity firms operate on the buy-side of investment agreements, while investment banking operates on the sell-side. Investment banks also offer a wider range of financial services to their clients while private equity firms are generally specialists in private sector acquisitions due to the purpose of their investment funds.

If you want to learn more about other investment approaches reserved for accredited investors, check out our article on private credit or debt. For a deeper dive into capital management, check out our comparison between wealth management and private banking.