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.

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.

Superclass and the New Elite

I've mentioned my obsession with the ultra-wealthy before. Reading David J. Rothkopf's The Superclass: The Global Power Elite and the World They Are Making today I was stuck by the utterly unoriginal insight that it might not be that much fun being an elite.

Rothkopf punctures a lot of the usual paranoid beliefs about a mysterious global elite - he observes that conspiracy theories are almost always psychologically comforting fictions: it is disturbing to think that one man, working alone, can assassinate a president.

This fact suggests a random and capricious universe. Much better to imagine that bad things that happen are the result of organised conspiracy.

However I do feel that it isn't really worth being a member of any kind of global elite.

The symbol of the global elite

Constant pressures on your time; scrutiny from the press, your peers, and governments; concerns over kidnapping, and the happiness of your friends and family would probably nullify most of the advantages of being extremely wealthy and/or powerful.

No, not for me famous, multi-billionaire status. Give me £30 million and obscurity, reputably and happily earned, and I will be satisfied.

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.

Morals and Markets with Robert Skidelsky

Economics boffin Robert Skidelsky has written an interesting article over at CiF about the morality of capitalism, this is my paragraph-by-paragraph response:

"...Because no social system can survive for long without a moral basis..."

This isn't really correct. Slavery persisted for centuries in the ancient world as the economic prime mover and yet was and is morally suspect.

"...It has often been claimed that capitalism rewards the qualities of self-restraint, hard work, inventiveness, thrift, and prudence. On the other hand, it crowds out virtues that have no economic utility, like heroism, honour, generosity, and pity..."

I think this depends on other cultural factors. Capitalism may encourage or discourage certain characteristics, but it doesn't mean these don't exist.

Also it isn't entirely true that honour and generosity are "crowded out" - good businessmen and businesswomen know the value of honour and generosity.

"...For quality of life, we have to rely on morals, not markets..."

This is very true.

"...But it is truer to say that the market economy is sustained by the stimulation of greed and envy through advertising..."

I wonder if it is useful to distinguish between capitalism and consumerism, and if it is useful to distinguish between "good" (buying organic, locally produced, low-CO2-profile vegetables) consumerism and "bad" (cigarettes) consumerism?

"...In a perfectly competitive market, with full information, models of the market show that all the factors of production receive rewards equal to their marginal products, ie all are paid what they are worth..."

As in the market, so in life. If everyone had "full information" we'd all be much happier. But because having "full information" is unfeasible it isn't useful to use this as a stick to beat capitalism with.

"...But no actually existing capitalist market system spontaneously generates justice in exchange..."

This is why liberal democracies have (democratically elected) representatives who control the state and who provide justice.

"...That is why the liberal theory of justice demands at a minimum equality of opportunity: the attempt - as far as is compatible with personal liberty - to eliminate all those differences in life chances arising from unequal starting points..."

Sorry, I should read down further before I comment. I agree completely.

"...Finally, the claim that everyone is - under ideal conditions - paid what they are worth is an economic, not a moral, valuation..."

Yes, I agree with this.

"...The simplest way of doing this is to restrict advertising. This would prune the role of greed and envy in the operation of markets, and create room for the flourishing of other motives..."

Governments do restrict advertising. "Re-moralising" wants is an interesting idea. But I don't see how "restricting" advertising accomplishes that.

Promoting morality is a difficult thing to do without being morally puritan and judgmental of other people's pleasures.

I would say that a good step would be to replace "RE" lessons in UK schools with "morality and ethics" lessons where students were taught about different moral and ethical structures and asked to consider moral and ethical problems.

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.

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.