I just finished reading two books on private equity and hedge funds, respectively. The first was “King of Capital”, a book about how Steve Schwarzman founded Blackstone and grew it to be one of the largest private equity firms in the world. In case it’s the first time you heard about private equity firms, they are professional money managers similar to venture capital firms (this is why people often time lump those two together and call them VCPE), but different in the types of companies they invest in. While VCs invest in high-tech startups, PEs invest primarily in industries that have established business models that makes it easier to predict future cash-flows.

PEs usually target companies that seem under-valued, buy them at a cheap price, manage them for several years, and re-sell them at a higher price. Safeway, one of the major grocery stores in the west coast, is a huge success case for Blackstone. Safeway was a family-owned business that had the potential to be much bigger and better managed, but the family owners were interested in merely maintaining the status-quo. Blackstone offered them a sweet price, turned them private and later went public again to rack in a huge profit. This kind of buying activity is called “leveraged buyout (LBO)”. The reason is that PE firms leverage heavily (basically borrow a lot of money) to cover the cost of buying an entire company. This leveraging is the key ingredient behind astronomic profits of these PE firms. For example, let’s say company A is worth $1B and a PE firm is trying to buy 100% of the company. Let’s say they put in $100M out of their pocket and leverage the rest, $900M. Let’s say the PE firm does a great job turning the company around and a year later company A is sold at $2B. Assuming the interest on the $900M was 10%, the PE firm needs to pay $90M to the banks, and the rest of the gain, $1B – $90M = $910M, goes to the PE firm. Basically they get a 910M/100M = 910% return with heavy leveraging compared to 200% return without leveraging.

Blackstone was very successful in these deals until the 2008 financial meltdown. Schwarzman would rack in over $300M in salary and compensation in a good year (but in a bad year get just over $300K). Most PE firms have very few employees (Blackstone has 1400), allowing even the lower ranking people to enjoy good compensations. No wonder a ton of MBA graduates line up for VCPE firms.

The second book was “Money Mavericks”, written by a ex-hedge-fund manager about how he founded and grew his first company, Holte Capital. He is not as famous as Steve Schwarzman and his company was also much smaller than Blackstone, managing about $500M-1B (Blackstone has $150B asset under management, AUM, as of 2010). What attracts me to hedge-funds, although I have no intention of joining one after my PhD, is that they seem like a no bull-shit industry. They don’t care about where you went to school, whether you have a PhD or not, whether you have a network of influential friends. They just care about your quarterly performances (or maybe monthly). If you earn a lot of money through trading, you can be a multi-millionaire at a young age with little to no experience. I got the same impression reading other books about the hedge-fund industry such as the “The big short” by Michael Lewis. It’s a place where your success is entirely based on how you perform. No bull-shit, meritocracy rules.

These two books are primarily about professional money managers, but also contains strong messages about entrepreneurship. I have read a few finance related books (More money than god, The big short, Too big to fail, Wall street meat, Running Money and the two books in this post), and the reason I keep reading them is because I can feel the entrepreneurial energy and the adrenaline of running your own company. I am basically relying on books to feel this before I can actually have the chance to feel it in the real world =) The initial days after starting financial firms seem very similar to those of high-tech startups. Lars Kroijer founded Holte Capital when he was 29 years old, after working at Lazard (a PE firm) for two years, studying at HBS for two years and working three years at another hedge fund. Having no track record of running his own fund, he and his buddy from Harvard had so much trouble raising the $5M to take his company off. Even after they somehow raised that money, the management fee they could get from $5M (2% x 5M = 100k) was too small to cover even their basic expenses like office rent and Bloomberg terminal fees. They were in the brink of shutting down their fund. All the major investors would say they were interested, but wanted to join once another major firms committed. After hundreds of meetings with potential investors, getting embarrassed and humiliated, hard work (and a little bit of luck) paid off. They were finally able to secure a >$10M investment and the rest was history. Sounds a lot like a high-tech startup scrambling for funding. I’ve heard a lot of stories about VCs investing in groups to reduce risk, waiting for their friends in other VC firms to commit to the funding round. Moreover, the spirits of the founders are remarkably similar. They have a strong will to run their own show even though their firm might have a name that no one recognizes.

Lars Korijer was 29 when he started Holte Capital, and was 37 when he quit, by which time he earned enough money to send his twin daughters to private schools while never worrying about money again. About to become 27 this coming November, I was wondering what I have accomplished compared to this guy who had 5 years of experience and financial firms (with >$200K salaries) and a Harvard MBA under his belt at my age. I’m not saying my PhD was not worth my time. This book gave me a chance to look back and think whether I did what I could to make the best of my time. Maybe I could have tried harder to become more professional about what I’m doing instead of acting more like a student. Reading these books make my desire to go out to the real world stronger than ever. I can’t wait to use my skills that I learned from my time at Harvard to run my own show. I need to first work hard to graduate next year =)

One last thing. Although hedge funds like Holte Capital seemed to have an academic working atmosphere, Blackstone had a completely different one. An impressive part in the book was about the conversation between Schwarzman and Callahan after Callahan had mis-managed a telecom company deal, leading to a huge loss. “Where’s my fucking money, you dumb shit?” were the first words out of Schwarzman’s mouth. I wonder what it would be like to work in such a competitive environment =)

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