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Private Equity--State of the Industry


Approximately 4,590 private equity firms are headquartered in the United States, but firms are located throughout the world. Some firms specialize in a particular investment strategy (such as growth equity, leveraged buyout, distressed buyout, venture capital, and mezzanine fund), while others use some or all these strategies.

Like their venture capital cousins, private equity firms generally find specialties within the industry. Some firms focus on middle-market, mid-cap transactions, while others take aim at overseas purchases (specializing in a particular geographic region such as the Middle East, Sub-Saharan Africa, or Southeast Asia). Still others look at small, public companies or those within a specific sector. Here’s a breakdown of PE investment by industry in 2016, according to the American Investment Council:

  1. Information Technology: 36 percent
  2. Business Services: 24 percent
  3. Consumer: 14 percent
  4. Energy: 11 percent
  5. Health Care: 8 percent
  6. Financial Services: 5 percent
  7. Materials and Resources: 2 percent

Then there are the big firms. They have the money and clout to go after the biggest deals in a variety of sectors. These include Apollo Global Management, Blackstone Group, Carlyle Group, KKR, Bain Capital, and TPG.

Firm and Fund Structure

Private equity firms typically consist of:

  • Limited partners, which are outside investors who provide the capital. They typically comprise institutional investors (such as pension funds, foundations, banks, endowment funds, and family investment offices), as well as high-net-worth individuals.
  • General partners are skilled investors who manage the business and all the parts of the investment cycle.

Most private equity funds are organized as limited liability corporations or limited partnerships and have a finite life span (10 to 12 years). Typical stages of a fund include:

  1. Organization/Formation
  2. Fund-Raising
  3. Deal Sourcing and Investing
  4. Portfolio Management
  5. Exit

Large private equity firms aim to create multiple, successive funds in order to ensure liquidity and steady profits.

Who Are Private Equity Investors?

The institutions and people who invest in private equity funds are some of the wealthiest in the world. Major pension funds, such as the California Public Employees Retirement System (CalPERS), place some of their money with private equity funds to boost returns. Investment banks with less than $10 billion in assets can place investments in private equity funds (per the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018)—unless, of course, they create their own in-house private equity funds as did Goldman Sachs and Morgan Stanley.

Hedge funds often invest in private equity funds due to the outstanding performance these funds have amassed through the years. Indeed, a few hedge funds have blurred the line between themselves and private equity firms by taking part in public company buyouts either on their own or in partnership with more traditional private equity firms.

And finally, the firms themselves are often heavily invested in their own private equity funds. The private—and, recently, public—companies that manage private equity pools ensure their interests are aligned with those of their investors by placing a large chunk of their own wealth in the mix. This has, of course, resulted in the creation of a breed of private equity deal makers that have joined the billionaires’ club, most famously Henry Kravis at KKR or Steve Schwarzman of Blackstone.

The Role of the Private Equity Firm

These investors don’t want to manage these big-value, big-return investments themselves. Indeed, CalPERS is outstanding at managing money and making sure millions of California retirees get their checks each month, no matter the market conditions. But do they have the expertise to find a good company to buy, run that company, and then bring it public or sell it? That’s where the private equity firms come in.

A private equity firm plays multiple roles throughout a typical investment. For example:

  • Raising the fund. The private equity firm serves as a focal point for private capital. The firm raises capital from the various constituencies mentioned above, and then manages that capital appropriately until an investment is identified. In addition, the same people who raise capital also help obtain credit for any leverage needed for a buyout. Finally, they manage payouts to all involved.
  • Finding a target. Firms employ researchers whose job it is to analyze the operations of thousands of companies, looking for potential investments. Sometimes it’s easy—many companies readily announce they’re looking at “strategic options,” business-speak for putting themselves up for sale. But there are plenty of opportunities at other companies as well, even ones that seem to be operating just fine. The researchers know the strengths of the private equity firm’s various management teams, and can identify potential targets based on the firm’s ability to generate even more profits from their strengths. And in still other cases, a fund may simply see a very conservative company under utilizing its resources—a chain of casual dining restaurants, for example, that hasn’t leveraged the real estate it owns to the degree it could in order to expand. There are plenty of ways to find a target, which we’ll discuss later on.
  • Closing the deal. The fund must then approach the company—or, in some cases, manage a company’s approach to it—and try to make a deal. This is very much like the merger-and-acquisition dance two publicly traded companies might make. The private equity firm generally hires a Wall Street investment bank for its advisory business, though its own cadre of deal-makers and due-diligence teams are often just as talented as those of the advisory firm. A deal is hammered out that usually gives the company’s current shareholders a premium over the stock’s current price, while giving the private equity firm enough room to make an even more impressive profit down the road.
  • Running the company. Once a private equity firm buys a company, the deal generally fades from the news, but the hard work is just beginning. The firm, which represents the new owners, has a plan for maximizing profits ready to go—that was part of the targeting and acquisition process. The firm then brings in the individuals it thinks can execute that plan. Such plans often include a wide variety of cost-cutting measures, including new management and production processes as well as layoffs. It also typically includes borrowing quite a bit of money—generally far more than investors in a publicly traded company would stand for. As a rule, private equity firms are aggressive managers, and the leverage is put to work immediately. In recent years, that leverage has also served to give the fund’s investors an early payout—essentially using the company’s good name to sell bonds, the proceeds of which are then distributed to the new owners. One of the biggest debates about private equity is whether debt is justified or even ethical, but when a company goes into private hands, there’s little regulators can do.
  • The exit strategy. There are a number of ways to unwind an equity investment and collect the profits. One is to sell the company to another entity, generally to an already-established company that was identified as a possible buyer early on in the due-diligence process. The private equity firm has done all of the hard work, after all, making it more attractive for a major corporation to buy. Alternatively, there are some companies that are simply bought for parts and their assets and property sold off. Finally, and most notably, the private equity firm “flips” the company, returning it to the public equity markets through an initial public offering. In general, the company has to be stronger than it was when purchased for the private equity investors to get a good return, though in some cases— notably the Hertz IPO—the companies can be overloaded with debt. The private investors generally receive the proceeds of the IPO, though in some cases at least part of the proceeds will go to the company itself.
Snapshot of the Industry Today

Today, there are more than 4,590 private equity firms in the United States alone, according to the American Investment Council. Total assets under management (AUM) reached $2.83 trillion worldwide in June 2017. According to a 2017 survey by Preqin, a record 53 percent of investors planned to increase their allocation to private equity over the long term.

PE firms now have stakes in more than 13,000 companies across the world. These companies employ more than 20 million people, and for each additional $1 million they invest, it’s estimated that they create an additional 10 jobs, according to “Private Equity Investment and Local Employment Growth: A County-Level Analysis,” by Josh Cox and Bronwyn Bailey, from the American Investment Council.

The 10 largest private equity firms in the world by amount of funds raised over a five-year rolling period ending April 1, 2018, were:

  1. The Carlyle Group (headquartered in Washington, DC)
  2. The Blackstone Group (New York)
  3. KKR (New York)
  4. Apollo Global Management (New York)
  5. CVC Capital Partners (London)
  6. Warburg Pincus (New York)
  7. EQT (Stockholm, Sweden)
  8. Neuberger Berman Group (New York)
  9. Silver Lake (Menlo Park, CA)
  10. TPG (Fort Worth, TX)

The industry is quite fragmented; the four largest firms (The Carlyle Group, The Blackstone Group, KKR, and Apollo Global Management) hold only about 15 percent of industry assets under management. Many firms have fewer than five employees, and even the largest firms typically have only 200 to 1,500 employees. The Carlyle Group, for example, has the most assets under management, but only 1,575 or so professionals operating in 31 offices in North America, South America, Europe, the Middle East, Africa, Asia, and Australia.

Private equity firms are located throughout the United States and the world. Many U.S.-based firms are headquartered in New York, Boston, and other cities on the East Coast; Houston and Dallas, Texas; Chicago; and San Francisco, Menlo Park, Palo Alto, and Los Angeles, California. Many of the top U.S. firms have offices in foreign countries. Apollo Global Management, for example, has offices in eight countries (including the United Kingdom, Germany, and China), and The Blackstone Group, in addition to U.S. offices, boasts a presence in Beijing and Shanghai, China; Dubai, United Arab Emirates; Dublin, Ireland; Düsseldorf, Germany; London, United Kingdom; Hong Kong; Mumbai, India; Paris, France; Seoul, Korea; Sydney, Australia; and Tokyo, Japan.

As the economy continues to improve, private equity firms are raising more money to invest. A total of 277 private equity firms raised $1 billion or more in funds during a five-year rolling period that ended on April 1, 2015, according to Private Equity International, a global news service that focuses on the PE industry. Fifty-eight percent of these firms are headquartered in the United States, 11 percent in China, 8 percent in the United Kingdom, 3 percent in France, and 3 percent in Brazil.

Preqin estimates that private capital firms worldwide employed approximately 163,000 people in 2016. There will continue to be good opportunities for private equity professionals. One fast-growing career is that of financial analyst. Job opportunities for analysts who work for securities, commodities, and other financial investment and related firms are expected to grow by more than 15 percent from 2016 to 2026, according to the U.S. Department of Labor, or much faster than the average for all careers.

Women and ethnic minorities are vastly underrepresented in the private equity industry. While half of U.S. investment capital comes from women, in 2017 only 17.9 percent of all private equity professionals worldwide were women, according to Preqin, an alternative investment research firm. And only 9 percent of senior managers and executives were women. Several organizations are working to increase diversity in the field and represent the professional interests of private equity professionals from diverse backgrounds. These include the Association of Women in Alternative Investing, Women’s Association of Venture and Equity Inc., Private Equity Women Investor Network, 100 Women in Finance, and the Association of Asian American Investment Managers.

Many noteworthy professional organizations serve those working in the private equity industry and related alternative investment industries.

  • The American Investment Council is an organization of private equity firms and funds-of-funds.
  • The Association of Women in Alternative Investing is a membership organization for women in the private equity, hedge fund, and venture capital industries.
  • The Emerging Markets Private Equity Association is a global membership association whose mission is to “catalyze private equity and venture capital investment in emerging markets.”
  • The Women’s Association of Venture and Equity Inc. is a membership organization that offers networking events and other resources.
  • The CFA Institute offers certification and continuing-education opportunities. It has more than 142,000 members in more than 150 countries and regions.

The Chartered Alternate Investment Analyst Association provides a well-respected continuing-education program and certification.

The Investments and Wealth Institute provides certification, continuing education, and other resources to its members, which include investment consultants and analysts, accountants, and others who provide financial services and advice to corporations, individuals, nonprofits, and retirement/pension plans.

The CMT Association is a nonprofit professional regulatory organization of 4,500 market analysis professionals in more than 135 countries. It provides certification, publications, and continuing education opportunities.

Current Trends and Issues

The private equity (PE) industry is constantly changing as a result of bear and bull markets, government legislation, business trends, globalization, and many other factors. Another major trend is the increasing specialization of firms. “The proliferation of sector-focused funds continues and we don’t expect that to change,” says Andrea Auerbach, managing director and global head of private investment research at Cambridge Associates and co-author of the Declaring a Major report. “The industry is over 30 years old now and continues to evolve towards specialization. Our data shows firms with sector specialization have a competitive advantage.” A second trend is the increasing use of data analytics, artificial intelligence, and blockchain technology (which can be defined as a distributed ledger database that maintain a continuously-growing list of financial records that cannot be altered) to improve efficiency, better ensure the accuracy of data, and solve other problems both in-house and at portfolio companies. Finally, large PE firms—such as The Carlyle Group and Blackstone—are launching buyout funds that have a longer holding period than the traditional three to five years. These funds have expected holding periods of 10 to 15 years. “Such patience…presents an opportunity to generate higher returns on committed capital over the long haul,” according to Forbes. These are only a few of the trends and developments that will shape the future of the industry.

Private Equity Funds Will Continue to Expand into Emerging Markets

Although the level of investment risk is higher in emerging markets than in the United States, U.S. private equity firms are continuing to look for investment opportunities in emerging markets. Investors poured $235 billion into emerging markets in 2017, according to the Institute of International Finance. The rewards are currently outweighing the risks (e.g., market volatility caused by political uncertainty, financial systems and regulatory agencies that greatly differ from those of the United States, natural disasters, etc.), and the professional-services firm McKinsey & Company believes that annual investment in emerging markets will reach $24 trillion by 2030.

In addition to the traditional emerging markets of Brazil, Russia, India, and China, private equity firms are increasing their investments in Bangladesh, Colombia, Egypt, Chile, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, Panama, Peru, the Philippines, Qatar, Saudi Arabia, and Vietnam. Private equity investment in Central and Eastern Europe (CEE) is also increasing, although PE investments in the CEE region represented less than 0.1 percent of total assets under management of the global PE industry in 2016, according to the annual report Invest Europe. Turkey, Poland, Kazakhstan, Georgia, Armenia, and Ukraine ranked as the most attractive CEE countries to PE investors.

Fees Are Rising Again

Private equity firms typically collect transaction and monitoring fees for consulting, management, and other services provided to the companies they acquire. Historically, these fees provided a lucrative revenue stream that augmented the firm’s share of investment gains on deals (the key source of profits for PE firms). For example, The Carlyle Group LP, KKR, and Apollo Global Management LLC reported earning $9 billion in management fees from their private equity businesses between 2008 and the end of 2013, according to the Wall Street Journal. But, for several years, increasing scrutiny by regulators regarding financial transparency and pressure from pension funds and other institutional investors prompted big PE firms such as Blackstone Group, TPG, and KKR to turn these fee amounts over to investors in the funds. Cash was not actually paid out to investors; instead, firms lowered by a similar amount the separate management fees owed to them by investors.

In the last few years, the PE industry has experienced record fundraising and rising investor demand, which has prompted many firms to increase their fees. “The private capital industry is enjoying a period of almost unprecedented fundraising, as record distributions and often ambitious allocation plans spur investors to

commit ever-increasing amounts of capital to private capital funds,” said Selina Sy, editor of a Preqin report about the trend. “This is particularly true of larger fund managers with proven track records: some of these firms are able to raise record-breaking funds in the space of a few months, and many managers are reporting that their latest vehicles are extremely oversubscribed.”

More High-Wealth Individuals Are Investing with Private Equity Firms

Fund managers are seeking to combat thinning profit margins by targeting high-wealth investors. High net-worth individuals in the U.S. had nearly $18 trillion of assets at the end of 2016, according to Capgemini, up from about $11.4 trillion in 2011.The amount of private equity capital contributed by high-net-worth individuals hit the 10 percent mark for the first time ever in 2014, up from 6 percent in 2008. “This is an important development to watch and a direct challenge to money-management teams at, for example, Morgan Stanley and The Goldman Sachs Group Inc.,” according to Investment News. “Both banks pool funds from rich people to funnel into buyout firms, taking fees along the way. Now private equity is trying to cut out the middle man—namely, the brokers at big money-management units at large banks.”

Regulatory Peaks and Valleys

The private equity industry was largely unregulated for decades. That changed in 2010 with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires all private equity firms with more than $150 million in assets under management to register with the Securities and Exchange Commission (SEC) and to hire a chief compliance officer to create and monitor a compliance program, disclose more information about investor agreements, and submit to regular SEC inspections, among other rules. Additionally, the Volcker Rule, a regulation in Dodd-Frank, restricts banks from conducting certain investment activities with their own funds and prohibits them from investing in or sponsoring private equity or hedge funds.

One recent piece of legislation, the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, rolled back parts of Dodd-Frank for smaller banks. The act changed the financial threshold in which banks could be classified as “systematically important financial institutions” from those that had more than $50 billion in assets to those with $250 billion in assets. The Wall Street Journal reports that the number of banks facing tougher financial regulation is expected to drop from 38 to 12. Additionally, the act also provides smaller banks with relief from the Volcker Rule. Banks with less than $10 billion in assets may now invest in or sponsor private equity or hedge funds and engage in proprietary trading.

In the short term, the trend now is toward deregulation, but seventy-three percent of private equity and hedge fund executives surveyed by Koger believed that a new presidential administration would likely strengthen financial regulations in the future.

Despite the de-regulation of the private equity industry, Pensions & Investmentsreports that “publicly traded private equity firms will still have to be regulated by the SEC and non-traded private equity firms will still need to file certain information with federal regulators. Also, private equity firms raising money abroad already comply with far more stringent regulations than those in the United States.” Investors also may pressure PE firms to retain the increased transparency mandated by Dodd-Frank and other laws. Ninety-two percent of members of the Institutional Limited Partners Association support SEC registration and oversight of the PE industry.

Interest Growing in the Tech Sector

Between 2006 and 2016, private equity investment in information technology–related companies grew from $48 billion to $149 billion, according to the American Investment Council (AIC). Information technology was the most popular investment sector for private equity firms in 2016. “Technology companies’ preference to stay private provides an opportunity for PE firms,” according to the AIC. “Large tech deals are driving investment volumes. Examples include Michael Dell and Silver Lake’s acquisition of Dell Technologies in 2013 for $24.9 billion…and Apollo’s acquisition of Rackspace in 2016 for $4 billion.” The private equity industry is especially interested in the software sector. Almost 50 percent of PE investments from 2006 to August 2017 were made in software.

Here’s a breakdown of PE investment by industry in 2016, according to the American Investment Council:

  1. Information Technology: 36 percent
  2. Business Services: 24 percent
  3. Consumer: 14 percent
  4. Energy: 11 percent
  5. Healthcare: 8 percent
  6. Financial Services: 5 percent
  7. Materials and Resources: 2 percent
Growing Concerns About Cybersecurity

In recent years, high-profile data breaches have spurred alternative investment firms to spend more of their budgets to ensure that data and intellectual property is protected from cybercriminals. The U.S. Securities & Exchange Commission, other federal agencies, and foreign regulatory agencies are also pressuring private equity, venture capital, and other alternative asset management firms to focus more on cybersecurity. Seventy-three percent of private equity and hedge fund executives surveyed by Koger (a financial services software provider) in 2018, believed that cybersecurity threats were the biggest risk to firm profitability. Investors such as pension funds and endowments are also pressuring private equity firms to institute stringent cybersecurity protocols. Cybercriminals steal or destroy data, conduct ransomware attacks, and perform other acts that force the private equity firm to lose control of investor or in-house data. Look for private equity firms to ramp up their cybersecurity budgets in coming years to address these threats. This will increase demand for information security experts.

Brand Building Becoming Important for Private Equity Firms

Private equity (PE) funds are facing a much more competitive landscape than in the past. They must compete with other alternative sectors, as well as the mainstream financial sector, for funds. They also must compete with the growing number of PE funds for deals and investor dollars. As a result, more PE firms are focusing on developing or improving their brands to attract clients and develop a stronger reputation in the industry. In fact, 70 percent of PE firms surveyed in 2017 by BackBay Communications, a strategic integrated communications firm, said that having a strong brand was very important. Thirty percent said it was somewhat important. “There is consensus among PE firms that building a strong brand is essential for deal sourcing, fundraising, and recruiting, said Bill Haynes, president and CEO of BackBay Communications. “Just as there is competition for new deals and limited partner funding, there is competition for mindshare among limited partners, investment bankers, business brokers and management teams, and forward-thinking PE firms are making a commitment to clearly convey the reasons investors, advisors and companies should work with them.”

According to the survey, PE firms say that the attributes that contribute most to a strong brand are:

  • Investment returns (79 percent of respondents cited this attribute)
  • Management team (63 percent)
  • Clearly articulated firm positioning (53 percent)
  • Content that demonstrates a firm’s expertise (47 percent)
  • Firm culture (47 percent).

Private equity firms said that the most effective strategies for building their brands were:

  • Creating strong investment returns (79 percent of respondents cited this attribute)
  • Investment discipline (63 percent)
  • Building a cohesive firm culture (58 percent)
  • Personal meetings (63 percent)
  • Conference speaking (58 percent)
  • Marketing materials (47 percent)
  • Web sites (37 percent)
  • White papers that demonstrate a firm’s expertise (37 percent)
  • Media interviews (32 percent)

The need to implement or improve these strategies suggests that demand will increase for marketing workers, investor relations specialists, public relations experts, and information technology professionals with knowledge of the private equity industry.

Industry Outlook

The private equity sector has bounced back after several years of poor performance caused by the economic recession. The number of private equity deals that closed in 2017 reached 4,191, according to Preqin, significantly higher than the 2,376 deals that closed in 2010 soon after the recession. The recession led cautious firms to hold rather than invest hundreds of billions of dollars in capital, and they are now seeking to commit that money to companies. Opportunities should be best at large, well-known investment houses because investors are shying away from perceived risky investments with smaller firms. According to Preqin, “the largest, brand-name managers are receiving the majority of investor commitments, with smaller managers—particularly first-time funds—finding it difficult to raise capital.” Hugh MacArthur, global head of Bain & Company’s Private Equity practice, says that “investor enthusiasm for private equity endures, leaving the industry awash with cash. This is both a blessing and a curse. Funds have ample money to spend, but the competition for deals is fierce. With deals being done at record-high multiples, the right sort of diligence is more essential now than ever before.”

The global research firm IBISWorld reports that the “private equity, hedge funds, and investment vehicles industry continues to become an increasingly integral part of institutional investor portfolios and a mainstream part of the asset management market,” and that it is increasingly becoming a global industry due to the “rapid growth in assets under management due to rising global wealth, lower international financial trading barriers, a broadening global investor base, and an increase in the number of larger alternative asset firms that operate on a global basis.”

Preqin estimates that private capital firms (private equity, private debt, real estate, infrastructure, and natural resources) worldwide employed approximately 163,000 people in 2016. Demand continues for experienced and skilled private equity professionals. Job opportunities for financial analysts who work for securities, commodities, and other financial investment and related firms are expected to increase by more than 15 percent from 2016 to 2026, according to the U.S. Department of Labor, or much faster than the average for all careers. Employment for analysts who work with other types of investment pools and funding sources will grow by nearly 14 percent during this same time span.

In 2017, Preqin surveyed more than 170 of the top firms in the private capital industry. Seventy-two percent of respondents cited the investments/deal team as the function that was in the greatest demand from a hiring/retention standpoint. Corporate operations (e.g., accounting, human resources, information technology, legal) ranked a distant second at 10 percent, followed by portfolio operations (9 percent), investor relations-capital raising (4 percent), executive management (3 percent), and investor relations-reporting/marketing/support (2 percent).

The private equity space is undergoing immense change. The storied firms that blazed the trail for private equity investing in the 1970s, 1980s, and 1990s are now up against stiff competition from investment banks and hedge funds (some of which are partnering with private equity firms to do deals).

There will always be a need for private equity investing—and, thus, for private equity firms. Few other classes of investment can produce the kinds of returns that a well-run private equity fund can achieve. For institutional investors, private equity investing can unlock double-digit returns that can’t be attained with most other investments. Private equity investing also remains less tied to the vagaries of the stock market, and therefore it provides strong returns over time that only the best bull markets can match.

When it comes right down to it, a firm such as Blackstone, KKR, Carlyle, or Bain is just far better equipped—in money, experience, and ambition—to make private equity investing work. Hedge funds may dabble, and money-center banks and investment banks may open and close divisions based on ups and downs in the market, but most large private equity firms have remained steady through all kinds of economic conditions, gathering experience and knowledge that dilettante players simply don’t have.

And for the foreseeable future, there will always be companies open to a private buyout. If the demands on public companies were great during the bull market from 2003 to mid-2007, they are piling on even higher in today’s tense business environment. Quarterly revenue and earnings targets must be met, and stock buybacks and dividends are critical—stocks have been pummeled for even the slightest hint of weakness in earnings, and buybacks and dividends have become more prevalent as companies attempt to appease shareholders.

In addition, the requirements of the Sarbanes-Oxley Act—the regulatory law put in place after the Enron and Worldcom debacles—have proven to be onerous for many companies. Even if Sarbanes-Oxley’s requirements are relaxed in the future, private equity buyouts will always be a good opportunity for publicly traded companies to reinvent themselves outside of the glare of the public shareholders’ spotlight.

Many people will continue to be attracted to the industry as a result of its perceived prestige and the high salaries earned by PE professionals. Salaries for private equity firm managers rank among the highest in any industry. In 2016, the top eight private equity executives earned a combined $1.5 billion, according to the New York Times and Equilar, a board and executive data provider. These private equity firm executives earned nearly 10 times as much as the heads of banks. Private equity professionals received average earnings (base pay plus bonus) of $315,000 in 2017, according to the 2018 Private Equity and Venture Capital Compensation Report. Those without MBAs received $264,464. Earnings vary by the size of the firm, with those at large firms earning more than those at smaller firms. New hires start in the $100,000 to $120,000 range.