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.

The Accidental Pornographer: not actually a review

A brief summary of lessons learned from The Accidental Pornographer:

1. Do not fall in love with the concept before you have scoped out opportunities for expansion. Griffiths discovers that the potential market for his product is smaller than he assumed only after he is well into it.
   
2. Do not get hypnotised by the prestige of others. Griffiths uses M&C Saatchi for marketing, despite their high-cost.
   
3. In planning your cash-flow always bear in mind the worst case scenario.
   

I've actually met the author, Gavin Griffiths, though I didn't know who he was at the time. I was working in our local branch of WH Smith and he came in to ask if we had this book in stock, as he had written it and wanted to know if it had hit the shelves yet.

My fleeting impression of him was of an earnest and unobjectionable individual. This is reinforced by his book and his blog.

The book is recommended for much the same reasons as Paul Carr's book Bringing Nothing to the Party. It is story of business failure, though neither Carr or Griffiths fail completely.

And you learn more from failure than you learn from success. Karl Popper teaches us this.

In praise of failure

I disagree with the following part of In Praise of Idleness by Bertrand Russell:

But, I shall be told, the case is quite different when savings are invested in industrial enterprises. When such enterprises succeed, and produce something useful, this may be conceded. In these days, however, no one will deny that most enterprises fail.

That means that a large amount of human labor, which might have been devoted to producing something that could be enjoyed, was expended on producing machines which, when produced, lay idle and did no good to anyone.

The man who invests his savings in a concern that goes bankrupt is therefore injuring others as well as himself. If he spent his money, say, in giving parties for his friends, they (we may hope) would get pleasure, and so would all those upon whom he spent money, such as the butcher, the baker, and the bootlegger.

But if he spends it (let us say) upon laying down rails for surface card in some place where surface cars turn out not to be wanted, he has diverted a mass of labor into channels where it gives pleasure to no one.

Nevertheless, when he becomes poor through failure of his investment he will be regarded as a victim of undeserved misfortune, whereas the gay spendthrift, who has spent his money philanthropically, will be despised as a fool and a frivolous person.

What Bertie is missing is the value of the deductive tinkering in any new business endeavour.

What reading The Origin of Wealth has taught me is that the value of free markets lies in their ability to generate many new and interesting ideas, then apply a selection process to them, and then amplify the successful ideas.

Innovation does not just emerge from one Big Man with a Plan but rather from the collective efforts of thousands of competing enterprises, businesses, startups, and university faculties, all deductively tinkering their way around idea space.

Laying out surface car tracks, as in Russell's example, may not end up being economically useful, but if the business were (for example) to develop a slightly more efficient way of laying down track then there would be a positive outcome for humanity, if not for the erstwhile entrepreneur ¹.

The core lesson of The Origin of Wealth is that knowledge is value, and finding things out by trying and failing is a worthwhile activity, if not in the narrow rationally self-interested sense.

Update 02/03/2009:

Chris Dillow has a post up that has relevance to this point:

Labour is not just a cost, to minimized. It is - or can be - a form of satisfaction in itself - a way of asserting who we are.
It is on this point, of course, that Marxism starkly confronts neoclassical economics. Marx’s gripe with capitalism was that it transformed work from a means of expressing one’s nature into a force for oppressing and demeaning people. So great has been capitalism’s triumph that many of us don’t even appreciate the possibility that Marx could have been right. It’s just taken for granted that work must be alienated drudgery.

So not only is Russell missing the value of failure in business he also misses the fact that certain kinds of labour are enjoyable and that it is extremely difficult to determine beforehand what will make us happier and what will make us richer (in all senses of the word).

Hence trying and failing is good. Trying is good. And some kinds of work are good.




1. Unless he had the forsight to patent his improved track-laying process, then he could licence the method for profit. Humanity as a whole would still benefit from increased speed of track-laying and the innovation would become widely available after the patent expires.

Realisable fusion power

I commented on this fusion-fission hydrid reactor design on Futurismic a while ago.

Researchers at the university of Texas are developing a means to process spent nuclear fuel using fusion:

The scientists propose destroying the waste using a fusion-fission hybrid reactor, the centerpiece of which is a high power Compact Fusion Neutron Source (CFNS) made possible by a crucial invention.

The CFNS would provide abundant neutrons through fusion to a surrounding fission blanket that uses transuranic waste as nuclear fuel. The fusion-produced neutrons augment the fission reaction, imparting efficiency and stability to the waste incineration process.

The reason this is exciting is that it raises the possibility of a way of developing fusion technologies incrementally and economically. Instead of going all-out to build a nuclear fusion reactor in one step, putative nuclear fusion companies could market their wares as a means of processing the nasty transuranic waste output of conventional fission reactors.

This would provide fusion companies with a source of revenue to develop more advanced magnetic containment methods, and many of the other technical requirements of fusion electricity production.

The problem with fusion technology in the form of the ITER project is it's a massive, expensive, centralised, all-or-nothing endeavour.

I entirely support ITER: but it I'd love to see some this fission-fusion hybrid fuel cycle implemented in practice.

Charles Stross makes this point about incremental development but concerning the LiftPort group, a consortium that have made the mistake (as Stross sees it) of focusing on the development of an elevator system under the assumption that the revenue-generating fullerene cable technology would appear from somewhere else.

Blessed are the indolent

Laziness is a virtue. Those who can be bothered to tell you otherwise are clearly lacking it.

- Emery Finkelstein

Despite my limited experience of the world there are a number of things I have discovered about large organisations:

1. In any large organisation the amount of work to be be done will grow to consume all the time of all the people available for work.
2. As an organisation grows in revenue the number of people working for it will increase.
3. Activity does not equal accomplishment.
   

The first observation is an extension of Parkinson's Law that work expands to fill all the time available. Working for several months at a call centre has taught me that not only is this the case but that the more people there are in an organisation, the more work needs to be done, regardless of output.

The second observation is seemingly obvious: labour is a key factor of production after all, but it's importance relative to capital has shrunk over the last century.

And activity

In 1970 James Martin and others predicted that the confluence of Moore's Law and the growth of automation would result in most human toil being replaced with machine work. There were predictions that by the year 2000 a 3 1/2 day work week (4 days one week, 3 days the next) would be the norm.

And yet this has not happened.

Where did my utopia go?

Why have all the improvements in technology not lead to a consummate increase in leisure time as people have stopped working as hard as they once did and start looking to more important things?

I am developing a suspicion that a great deal of the jobs and careers of a large portion of people in the Western world are essentially useless.

A Keynesian might argue that any labour is good labour: even digging holes in the ground then filling them in counts as economic activity if the digger is paid. The digger can then spend their income buying food and services from others and thus the economy is stimulated.

But what if someone invents a digging-machine that does the work faster and for less money - what then?

Politicians (like Barack Obama) talk of "creating jobs" as if that were an end in and of itself.

This raises an interesting question: what is the ultimate end game of human civilization? Are we aiming for a society where no one has to work if they don't want to and leisure is plentiful?

Or do we want a hamster wheel society of people doing makework for no higher purposes than to stimulate the consumer economy?

Keynes had some thoughts on the endgame of human civilization [via Futurismic] in his essay Economic Possibilities for Our Grandchildren:

The strenuous purposeful money-makers may carry all of us along with them into the lap of economic abundance. But it will be those peoples, who can keep alive, and cultivate into a fuller perfection, the art of life itself and do not sell themselves for the means of life, who will be able to enjoy the abundance when it comes.

Charles Stross comments on the hamster wheel aspect of this problem with reference to the job-creating system otherwise known as Microsoft Windows.

At the root of all the great engineering, technological, medical, economic, philosophical, social, and political developments of the last few centuries is the constant desire to get more for less.

Nuclear weapons and ICBMs have made all-out war between industrial nations a monstrous mistake in every context. Therefore for a relatively small amount military effort a great gain of peace is achieved.

Cars and planes make transport easy and safe; drugs and surgery and antibiotics make life longer and less painful; central heating and air conditioning allow us to control our environments and build comfortable homes for a fraction of the relative cost to our ancestors of doing the same.

And as for me I think that cultivating the art of life itself is a much higher goal than mere money-grubbing.

Nassim Nicholas Taleb and Felix Dennis

In his answer to the recent Edge Question 2009 (What will change everything?) epistemiology philosopher Nassim Nicholas Taleb touches on a topic close to my heart [from Edge.org]:

People want advice on how to get rich –and pay for it. Now how not to go bust does not appear to be valid advice –yet given that over time only a minority of companies do not go bust, avoiding death is the best possible –and most robust --advice.

Taleb is fond of pointing out that the "how I did it" genre of business/entrepreneurship books is essentially useless as a source of business advice because all the writers (who he asserts consist entirely of successful, retired entrepreneurs) suffer from the survivorship bias - the only reason they're in a position to lecture anyone on how to succeed in business is they did not fail.

As huge numbers of business startups do fail and the defining component of success is not failing there is very little value to be gleaned from reading the memoirs of self-indulgent millionaires.

The exception is magazine entrepreneur Felix Dennis, owner of The Week and The First Post (both of which I have stopped reading on Taleb's advice).

The reason Dennis' book How to Get Rich was so disappointing to this reviewer was that the he found the book largely anecdotal [from the FT]:

...this book is not so much about how we could get rich as how Dennis did.

The author has the good taste to admit that you have to be a little lucky to get on the rich list - as well as brash and single-minded. Unfortunately, he also has enough bad taste to reprint some of his own poetry, most of which revolves around himself and his pots of money.

Dennis' poetry notwithstanding I found the book both highly general but also highlighted by a series of anecdotes that show just how lucky Dennis was.

His first big break was when he wrote an exclusive biography of a kung-fu practitioner Bruce Lee just before the star died in mysterious circumstances, resulting in a surge of public interest and demand just as Dennis published the book.

On another occasion when Dennis was flogging membership packs for the Bruce Lee fan club the packs were shown on TV by a journalist who felt they were bad value for money - as a result thousands more people bought them.

Yet another time it was discovered (as Dennis was en route to his Caribbean home of Mustique) that his publishing company was due to suffer a catastrophic cash-flow crisis. The discovery was due to a change in accounting software that highlighted the problem just in time to avert bankruptcy.

Dennis is entirely open that his success is in large part down to luck, but he also includes a very practical point: when it comes to getting rich, it's what you own that counts, not your prestige, not your job title, or personal power.

And Taleb is wrong to say that you don't get books that describe how not to start a business. Raconteur and new media whore Paul Carr does just that in his amusing and entertaining account of how he failed to become a wealthy and famous web tycoon entitled Bringing Nothing to the Party: True Confessions of a New Media Whore.

I'm gradually coming to suspect that entrepreneurship is for suckers - if you really want to become happy, it's best to get a well-paying and reliable job that you enjoy.

Or better yet, rather than be a hacker, be a backer. Taleb mentions somewhere in The Black Swan that investors in companies make more money overall than individual entrepreneurs.

This is perhaps the story to take away from The Second Bounce of the Ball by Apax founder Ronald Cohen.

"Success," like most other abstract qualities, is largely subjective. Life is for living, not ferretting around for dollars and euros. As Brian Micklethwait writes in his essay What the Success Books Say:

Success means having a success attitude. Success means thinking successfully. Success means having, or cultivating, a "positive mental attitude"

Putting aside my nerdy and maladjusted obsession with the wealthy I care more about living elegantly and happily than mere money.

More Felix Dennis

Felix Dennis made the front page of The Times today with this interview in which he claims he “killed a man.” It’s an extraordinary claim to make. From what I’ve read about the man it might just be possible; but it is far more likely that it is part of his usual self-aggrandising self-promotion.

Watching Felix Dennis

It seems that Dennis Publishing is setting up a new venture: Bash the Boss.

Currently I'm thinking in terms of a website that reviews companies by virtue of how good they are to work for.

Or it could be a little game where you score points for punching your boss in the face.

Whatever, I wish the good people at Dennis Publishing every success.

The First Post

I just discovered that the First Post, one of the better online news magazines is owned by Dennis Publishing, which is itself owned by none other than Felix Dennis!!

I'm fed up with blogging for today.

Sanity

Someone has finally written a sensible article on the whole "evil private equity guys are stealing our lunch money/less tax than a cleaner" story.

Polly Toynbee has been particularly irritating on this subject over the past few months.

Tim Worstall is making the very good point that the state shouldn't throw the baby out with the bath water on capital gains tax and reduce our country's entrepreneurial spirit.