Each year, Investec carries out a survey — GP Trends — in which we speak to hundreds of people working in private equity (PE). And each year the respondents tend to agree on one thing: financial service providers don’t understand their income profile.
Not only did 69% of UK respondents agree with this statement, it also rose in tandem with seniority.
Their wealth is usually tied up for years at a time
PE can be one of the best-remunerated industries out there. But there’s a very important differentiator: people working in finance tend to be cash rich but time poor — that is, they are well paid but often work long hours in a high-pressure environment. As a result, they want to get things done quickly with a minimum of fuss.
On the other hand, people in PE are certainly time poor — they can work long, stressful hours. However, not all are cash rich. Don’t get us wrong, lifetime earnings for someone in PE can be stratospheric, but the nature of the job means that the really significant riches come in lumps, and are often deferred by several years.
Remortgages can be an effective way to release liquidity without having to dispose of any assets
That presents the industry with a challenge: how do you offer appropriate financing — and for the sake of this article, mortgages — to someone with tremendous earning potential, but whose wealth may not materialise immediately?
Understanding a fund life-cycle
The key, naturally, is understanding how income streams work.
So let’s take a step back and remind ourselves how PE funds come into being. A group of enterprising people spot an opportunity in the market. They put their money in the pot and persuade others — pension funds, HNWs, etc — to do the same. These investors don’t directly control the fund, but they stand to benefit from the upside and are known as limited partners.
The founders put a big chunk of their personal wealth into the fund, known as co-investment, or co-invest. This is partly to reassure the limited partners, but is also a reflection of their faith in their own ability to generate returns. This faith in themselves tends to be well placed — historically, PE funds generally perform satisfactorily, and, if all’s gone well, five to 10 years later the fund starts to sell its investments.
The nature of the job means that the really significant riches come in lumps, and are often deferred by several years
Hopefully this is for a substantial profit, and at this point investors start to realise some serious wealth. Founders will receive their original stake, ideally with a significant multiple, but will also get an additional payment — a proportion of the fund’s profits after giving a preferred return to investors — to reward them for performance.
This is known as carried interest (often shortened to carry), and is effectively a proportion of the fund’s profit paid to those who were responsible for its performance (typically in front-office roles).
Carry is typically vested over a few years, and is on top of annual bonuses and basic pay.
The key, naturally, is understanding how income streams work
However, as one fund winds down another may be winding up, and people working in PE will be tying up wealth again in the next one.
How providers can help
At this point, you can probably guess the issue facing those in PE, particularly those on the first few rungs of the ladder. While basic pay is competitive, it’s bonuses and carry that provide a more substantial payday, and this wealth is usually tied up for years at a time.
This provides two mortgage-related opportunities. First, these aren’t cookie-cutter mortgages. For smart mortgage brokers who can partner with a bank that understands and is comfortable with complex income streams, there’s a real opportunity to add value. Look for a lender who can take into account co-invest, carry and bonuses, so long as it is evidenced (and not just future potential income).
How do you offer appropriate financing to someone with tremendous earning potential but whose wealth may not materialise immediately?
The second is the appeal of remortgages. People working in PE — particularly those slightly further along in their career — often have significant wealth tied up, and remortgages can be an effective way for them to release liquidity without having to dispose of any assets.
The opportunity
To stretch the statement made earlier, a good way to think about people in PE is that they are often not only time poor but at many stages of their career cash poor too — but also asset rich.
For a mortgage broker who understands this and is able to help PE clients, a significant opportunity presents itself.
Peter Izard is head of intermediary business development at Investec
