Friday, August 14, 2009

Of investment bankers, entrepreneurs, VCs, and life

One of the tragedies of investment banking as a profession is that although bankers are paid stratospheric amounts by the standards of most people they spend their entire careers working for the fraction of individuals who end up becoming (much) richer than they are.

Consider: a very successful fortysomething investment banker who has amassed some £5 million in net wealth is assisting in the public flotation of a company.

This company was started seven years ago by a 30 year old. This 30 year old managed to raise £2 million in capital from a VC in exchange for a 60% stake in the company after two years of trading.

Now 37 the entrepreneur is taking her company public, floating at a market cap of £500 million. The entrepreneur will sell half of her 40% stake (i.e. £100 million) to the market, and immediately reinvest half that amount (£50 million) in the business.

Her VC partners are similarly selling half their 60% stake (£150 million) to the markets, and reinvesting half this amount (£75 million) in the business.

The company will raise £125 million to invest in new plant and expand worldwide. If things go as expected the stake held by the entrepreneur will double within three years to £200 million.

Out of all this the bank takes a 1% fee for buying the shares initially. 1% of £225 million or £2.25 million. The banker expects to receive 10% of this in his bonus, or £225, 000. He has already advised on three similar transactions so far this year, and the year is nearly over, so he *expects* his bonus to be around £900, 000, on top of his salary of £200, 000.

Around half of this will be taken in income taxes (compared with 18% capital gains tax or £9 million in the case of the entrepreneur) leaving the banker with take-home pay of £550, 000. After the flotation the entrepreneur has £41 million in cash and a 20% stake in a company that is expected to be worth £1 billion in three years.

The banker end that year with net wealth of £5.55 million. The entrepreneur ends that year with net wealth of £141 million plus whatever is left over from dividends and what she paid herself over the previous 7 years.

This is the heart of the tragedy of capitalism. As the man said, you gotta serve somebody. The banker serves the enrepreneur who probably feels hard done-by that she didn’t keep a larger stake in her firm. The VCs will be happy, but they are accountable to their own shareholders who are themselves accountable to equity and pension funds, who are in turn accountable to clients who really just want to live a quiet life/retirement.

Overall, on average, society wins, but at the cost of everyone being just the tiniest bit pissed off at the place they ended up in the pyramid. So they’ll keep pounding away on the hedonic treadmill in the hope that something will come up.

1 comment:

Manu said...

But TJ you're forgetting how hard it is become even a moderately successful entrepreneur and how, well not easy, but infinitely less harder than being an entrepreneur, it is to become a successful Investment Banker.