Why work in Private Equity or Venture Capital?

1 May 2017

If you wish to amass Great Wealth and perhaps change the world - try Private Equity or Venture Capital...!

Would you like to make millions of dollars for yourself and have a phenomenally interesting and varied job?

Private Equity, and some areas of Venture Capital, have created many multi millionaires and a number of billionaires since the 80’s. I set out below how it is that many of these people became so wealthy, and why it makes sense to work in these fields if you want to have a very interesting job that also can also handsomely reward you, and also change the world, hopefully for the better.

Given that the USA and Europe sometimes define these terms differently, I am using the term Private Equity to mean primarily control buyouts where debt is taken on board, and some larger growth equity deals, and Venture Capital to mean everything from startups in the garage to expansion capital rounds that can be in the hundreds of millions of dollars and investment in companies as big as UBER or Snapchat.

Venture Capital - changing the world

If you want to change the world, then Venture Capital could be for you. Apple computer has changed everything, as have many other startups that have grown to be giants, such as Google and Facebook. The iPhone, and smartphones, has created many new industries… would UBER exist without smartphones? Would Facebook be as big without smartphones? Or Snapchat, Google or Whatsapp? Would the geopolitical landscape be different if Facebook, Google or smartphones did not exist? Does the fake news found on Facebook, influencing peoples voting decisions, change the political landscape? Do President Trumps Twitter tweets change peoples political opinions?

But so many people want to make a bundle by investing in the next Facebook or Google that the odds are not that great for it to be you, unless you work at one of the top 10 or so Silicon Valley Venture capital firms, or you are very lucky. They see the best deals and if they invest, entrepreneurs know that their investment is a stamp of approval as a likely good deal done by the smartest people so they can likely achieve a higher valuation on the next round of funding, so it becomes self perpetuating.

So if you can get in to the industry, in the right position, you can see many of the new things that will change the world for millions or billions of people over the coming years, or even make these things happen by funding the companies, from genomics to bitcoin to artificial general intelligence and flying cars and so on.

Visit CB Insights for free market maps on the latest changes and developments in new industries, the hottest companies, and the Venture Capital world. https://www.cbinsights.com/

But remember, it is extremely risky, and companies can come and go very rapidly. The leading search engines before Google came along were Yahoo, Ask Jeeves, Alta Vista and so on. Where are they now? Or before Facebook, there was Smallworld and MySpace, what is their position now? Or before Internet Explorer there was Netscape.. and so on

Many point to Steve Jobs starting Apple in a garage… so what happened to the hundreds of other PC companies at the CES- Consumer Electronics Show in Vegas in the early 1980’s…?

But if you can change the world for the better... perhaps you should "give it a go"!

Private Equity- making it big?

Buyouts ie taking control of a company and putting debt on and enhancing the companies operations to boost equity returns, have in general done spectacularly well since the 80’s. As the cost of debt decreased since the 80’s and debt became more available, asset prices moved up considerably, further enhancing returns to the PE firms. Just like buying a house with a huge mortgage as a percent of the value, you made a lot of money when house prices went up, and company values also shot up tremendously, making lots for their owners.

And Private Equity firms keep, in general, 20% of the gains, as long as they first achieve an 8% per annum return to their investors. And if you are also getting say 2% or 1.5% annual management fee on the committed (ie not drawn just pledged), they you can in many cases pay yourself handsomely. Each day you can investigate a new industry or area, evaluate strategies and market position, valuations, debt markets and so on, so a hugely interesting place to be if you have a curious mind and are prepared to work extremely hard.

So as global asset prices have shot up in the last 30 plus years, the more you borrowed and the more you bought, the more you made. Just ask Mr Schwarzman of Blackstone, or David Rubenstein and his Partners of Carlyle, or Leon Black of Apollo, or dozens of other Private Equity titans.

What happens if interest rates go up, or there is a recession?

The big question though is, if interest rates go up, what will happen to asset prices? Or if there is a blow out recession, what will happen to the companies that have lots of debt?

And as of the first half of 2017 the volume of deals climbed to $144bn, the highest since 2007. So the huge amount of “dry powder” (ie uninvested cash committed to PE firms) in the space, intense competition, makes one wonder what will happen to returns… will there be a repeat of the 2007/8 bust?

More and more PE firms are boosting their returns compared to the past by using “subscription financing”, in other words using the creditworthiness of their investors to get more or higher cheaper bank loans; currently a topic of discussion in the industry trying to examine the riskiness of such behaviour…

Returns to Investors- and the slice to the PE Firms

To see what people made by vintage year, the NET returns (ie after the PE firm has taken their 20% carry ie share of profits, and all expenses have been deducted) for many funds, you can visit the publicly available information on USA State Pension funds, such as CALPERS, State of Washington, State of Oregon, University of California Regents etc. See the CALPERS data here: https://www.calpers.ca.gov/page/investments/asset-classes/private-equity/pep-fund-performance. If you look at the fund size (available with google searches) you can see roughly how much the PE firm made… so a 2x NET fund, a $1bn fund, means that the main people in that fund took home well over $200m in carry (before personal taxes). You can do the math if it is a $15bn fund.

One can hope that the beneficiaries of these huge gains will significantly contribute back to society, as many do.