By Praveen Chunduru
Many people, both in and outside the field of investment banking/private equity, often wonder why there is so much money in the field. Bonuses that rival those of CEOs of small companies and profit figures that rival those of manufacturing giants. After all, these figures are not logical, as finance is merely an ancillary field, where no technical expertise of manufacturing or the soft skill of marketing is required. Plus, if you can cut down these exorbitant amounts, the logic goes, you can make funds available at cheaper rates to companies that need money.
However, I think there is an argument for high salaries and bonuses: there are, simultaneously, a very small margin for error, and innumerable areas where errors can be made. In a typical financial model for a company, you would have to make no less than a hundred distinct assumptions, ranging from the expected capacity utilization levels to how much overtime the target would pay its contractual employees. Each assumption can have a significant impact on the valuation of a target firm, and so even a minor error can mean that your company vastly overpays for its share in the target’s ownership, or worse, arrive at such a low valuation for the target that the idea of an investment is discarded at a very early stage.
While building financial models, seniors in fact have little control on the minute details that go into them. So the devil can lie in one wrong cell-linkage or one unrealistic assumption, caused by one momentary lapse of concentration in the endless hours on the job. In such an environment, you need a company made of several individuals who have almost an entrepreneurial control (and responsibility) over their respective field of the job. In a PE firm, analysts stick out their necks every time they make an assumption. If the investment goes wrong, it is investigated and inevitably all traced back to the one bad decision the analyst made.
What is not mentioned when the salaries are quoted is that the risk of losing one’s job in the PE field, not to mention a whole career, is astronomically high compared to nearly any other field, in or outside of finance (excluding maybe the armed forces). The fundamental problem with being an equity investor is that there are no safeguards, no ‘security’ over the target’s assets that assures returns. Foresight, precision, and most importantly, an eye for detail, are the vitals of this field. Unlike in any other field of finance, you as a PE analyst are involved in 1 or 2 deals in a year, each of which is critical to your company, and make hundreds of small decisions, each of which can be detrimental to your career.
This makes the case for hiring the best minds, with the assumption (another critical one) that the best minds make the fewest mistakes. I like to think of a PE investment as climbing a difficult mountain. Finance, as mountaineering, is a field in which the 80-20 rule doesn’t apply, and in which even 99% accuracy just won’t do. It therefore makes sense to pay high sums to attract those who promise to climb that last 1%, and risk their lives in the pursuit.