Every year, Investec conducts a survey – GP Trends – in which we talk to hundreds of people working in private equity (PE). And every year, respondents tend to agree on one thing: Financial service providers do not understand their income profile.
Not only 69% of UK respondents agreed with this statement, but it has also increased along with seniority.
Their wealth is usually tied up for years at a time
PE can be one of the highest paying industries out there. But there is a very important differentiator: People working in finance tend to be rich in cash but lack time i.e. they are paid well but often work long hours in a business. pressurized environment. As a result, they want to get things done quickly with a minimum of fuss.
On the other hand, people with PE are certainly short on time – they can work stressful long hours. However, not all are cash rich. Make no mistake, a person’s lifetime earnings in PE can be stratospheric, but the nature of the job means that really great wealth comes apart and is often delayed for years.
Re-mortgages can be an effective way to free up cash without having to give up assets
This poses a challenge to the industry: How do you provide proper financing – and for the sake of this article, mortgages – to someone with huge earning potential, but whose wealth may not materialize immediately?
Understanding the lifecycle of a fund
The key, of course, is understanding how income streams work.
So let’s take a step back and remember how PE funds were created. A group of enterprising people spot an opportunity in the market. They put their money in the pot and persuade others (pension funds, HNW, etc.) to do the same. These investors do not directly control the fund, but they should profit from the upside and are known as limited partners.
The founders invested a large part of their personal wealth in the fund, called co-investment or co-investment. This is partly to reassure the limited partners, but it is also a reflection of their confidence in their own ability to generate returns. This self-confidence tends to be well placed – historically PE funds have generally performed well and, if all goes well, five to 10 years later the fund starts selling its investments.
The nature of the work means that really important wealth comes apart, and is often delayed for several years.
Hopefully this is for a substantial profit, and at this point investors are starting to realize significant wealth. Founders will receive their original stake, ideally with a large multiple, but will also receive an additional payment – a proportion of the fund’s profits after giving investors a preferred return – to reward them for their performance.
This is called carried interest (often shortened to carry), and it is actually a proportion of the fund’s profits paid to those who were responsible for its performance (usually in front-line roles. -office).
The porterage is generally acquired over a few years and is added to the annual bonuses and the base salary.
The key, of course, is to understand how income streams work.
However, as one fund ends, another may be liquidated, and people working in the PE will tie up their wealth again in the next.
How providers can help you
At this point, you can probably guess the problem facing those in PE, especially those in the lower rungs of the ladder. While the base salary is competitive, it is the bonuses and deferral that provide the more substantial salary, and this wealth is usually locked in for years.
This offers two possibilities related to mortgage loans. First, these are not cookie-cutter mortgages. For smart mortgage brokers who can partner with a bank that understands and is comfortable with complex income streams, there is a real opportunity to add value. Look for a lender who can factor in co-investment, carry, and bonuses, as long as it’s proven (not just potential future income).
How do you offer the right financing to someone with huge earning potential but whose wealth may not materialize immediately?
The second is the call for remortgages. People working in PE – especially those who are a little further along in their careers – often have significant wealth, and remortgages can be an effective way for them to free up cash without having to give up assets.
To extend the statement made earlier, a good way to think of people with PE is that they are often not only time poor, but in many stages of their careers cash poor as well – 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 responsible for the development of intermediary activities at Investec