Imagine you could rub a lamp and a genie would appear offering to buy some proportion of your future lifetime earnings for £1 million.
How much would you give up?
- 1 per cent?
- 20 per cent?
- 50 per cent?
One man who believes in fairy stories is James Layfield, an entrepreneur who tells the Financial Times he will give up 10 per cent of his lifetime earnings for £1 million:
“I believe that this is the true sprit of entrepreneurship,” the 36-year-old said. “I am my own commodity.”
The offer is for a slice of Layfield’s entire lifetime earnings, although a clause would allow him to buy out his investor for a multiple of the original investment.
He is currently in negotiations with one wealthy individual.
I wouldn’t be negotiating, I’d be plying the fool with drink to get the million pounds signed over as fast as possible!
The article states James already has ‘three successful companies’, so perhaps this investment isn’t quite as crazy as it sounds.
On the face of it though, it’s a terrible deal for the investor and perhaps for the entrepreneur himself.
Why the wealthy investor must be nuts
Unless James is already earning a huge salary or has multi-million pound assets – in which case I can’t see why he’d give up 10 per cent of lifetime earnings for just £1 million – this deal sucks.
There are too many unknowns to do a precise calculation, but even the back of my napkin says it doesn’t add up.
Let’s first consider the investor’s opportunity cost – you can get a lot of interest on one million pounds.
Instead of investing in James he could get a risk-free rate of return from a long government bond.
Bonds are currently expensive, but you can still get 4.42% a year, plus your capital back, from a gilt that matures in 28 years.
- To keep the maths simple, let’s call it 4.5% to mature in 30 years.
So the investor could get an immediate annual income of £45,000 a year by buying £1 million worth of the gilts.
To get the same immediate return from his 10% investment in James, the latter would have to already be earning £450,000 a year, which clearly he’s not if he’s seeking this deal.
So the investor is looking to James’ long-term potential.
The article states that James is offering 10% of his earnings, not his net worth, but I’m going to assume it’s the same thing as otherwise the maths is horrible (you’d have to work out when James Ltd started paying out huge dividends in 20 years, or similar!)
What rate of return might the investor be looking for?
It will consist of:
- The risk-free rate – 4.5% from the gilt; plus,
- Inflation – say 2.5% over 30 years; plus,
- Risk premium – the big one!
The risks of this deal are almost impossible to quantify, but they include:
- James not bothering to set up any more companies
- James getting ill or dying (sorry James!)
- James setting up unsuccessful companies
- Legal risks
- The risk of James calling the deal by buying the investor out too soon
- The risk of James becoming a communist
- The risk of James getting married to a high-maintenance woman
- James going bankrupt
And so on and on and on.
If James was a blue chip share you might add 4% to represent the equity risk premium – the excess returns you get for buying a share over a bond, and putting up with the volatility and the risk of losing everything.
The risks with James are much higher. I’m going to call it 13%, but clearly you could make up almost any number because there is no past data on investing £1 million in spunky 36-year old entrepreneurs.
- A 13% risk premium gives us an expected annual return of 20% (risk-free rate, plus inflation, plus the risk premium)
Chucking this sum into a compound interest calculator gives us a final expected return of:
- £237 million in 30 years time
High, but perhaps not impossible for a brilliant entrepreneur.
But remember, the investor only gets 10% of James’ net worth!
This means the investor needs to expect James to be worth £2.4 billion by age 67, going on my assumptions, for the deal to stack up.
Clearly you can change the risk premium to produce all sorts of values. Yet even at equity risk premium rates he has to expect James to be worth nearly £230 million when he cashes in his investment. A heroic assumption to say the least!
Not so great for the entrepreneur?
If I could sell 10% of my future income for £1 million, I’d do it. Making one million pounds from saving and investing is hard work.
The reason I’d jump at the chance is a million right now is worth a lot more than £1 million in the future, due to the time value of money.
Of course, I’d immediately put it into investments earning at least £45,000 a year! From that I’d need to pay 10% to the investor (£4,500), making a huge annual gain on the deal.
Clearly, no investor is going to be barmy enough to sign up to that. We have to assume James will be legally obliged to invest the £1 million into various start-up companies, or else to fund the expansion of his existing companies.
Running your own business is very risky. Having an investor legally forcing you to deploy £1 million in high risk/reward ventures is even more dangerous.
James could be pressured into spending the money too fast, blow up, and so lose all he has built up already – plus he’d have that extra 10% tax on his earnings for life.
This is even leaving aside the usual problems of external investment, such as having to operate with someone watching over your shoulder and second-guessing all your moves.
Don’t get me wrong, I think James should take the money. I’m just saying even for him it’s not ideal.
Dumb money
If the investor was buying say 20% of one of James’ businesses, no problem – you, me and James could look at the books and the market and do the maths. The investment would be ring-fenced.
This is why limited companies were invented!
Clearly, this deal is not a financial one. It’s at best a punt for someone super rich to get a human hobby horse, and at worst it’s PR for cheeky James.
But if anyone dumb has £1 million to invest in a modestly-growing financial blogger, you know how to contact me!
Update: James has linked to this article from his own website, where you can read more about his £1 million funding ambitions.
Question: Would you sell sum chunk of your future earnings for a million? How much would you give away?
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A very interesting story and analysis.
I agree, I think I would probably do the same. Money is worth more when you are younger, even ignoring the discounted cash flow model.
I had a similar idea for a charity: I thought there must be so much wasted talent in the third world who aren’t fulfilling their potential because they could not afford to go to university. How many life changing inventions or cures for diseases have we not seen because their future inventors were not able to afford to go to school?
My idea was to have a charity that would pay for qualifying children to live and study at some of the best universities in the world. In return, once graduated and working (possible in the same country of study) they would return a percentage back to the charity for the rest of their life.
The excess would be used to fund the study of other talented children with who couldn’t afford to go to university.
.-= David deSouza on: Tax Rebate Forms – Tips and Advice =-.
I’d take the genie up on his offer. You just never know what the future holds and a ‘bird in the hand is worth two in the bush’.
I’d invest the £1 million in a diversified asset allocation and be prepared for a return of 4% or so after inflation for an average £40,000 per annum. Not a small amount compared to average/median UK salaries.
.-= RetirementInvestingToday on: UK House Price Thoughts =-.
@David – Yes, I couldn’t bothered to implement a proper discounted cashflow analysis, partly because I’m sceptical of the accuracy it purports to model, but mainly because it’s tiresome! 😉 Your charity idea is an interesting one, and slightly similar in fact to what I saw with people from developing countries who’d won a scholarship to my university in the early 1990s. They had committed to pay back certain loans, and if they didn’t get a 2.1 or First Class degree they had to pay fees as well. This came from the state, though.
@RIT – Agreed, I’m pretty sure I could create an inflation proof income (albeit suffering some volatility) from shares, property and select corporate bonds with £1 million. Unfortunately though, I’m pretty sure any investor in this case would demand I put the million into my start-up widget laboratory, or what have you!
I’d be up selling a portion of my future earns for million. I’d much rather use the money now then later in life. But then again, I hate debt. So having to repay someone a portion of my future earning doesn’t quite mesh with my values (at this time) Of course I think almost anything can be bought and a million would let me quit working one of my jobs now. Ok, Ok, I’ll take it 🙂
Mr. Devil where do I sign???
.-= Jeff on: How to Create Sinking Funds =-.
@Jeff – Yep, I think we’ve all agreed we’d take the million — but sadly in explaining our thinking we’ve also explained why no crazy rich guy would give us the money. He’d see no return!
Hello everyone. I wanted to give you a little update. Though I did not raise the money for the 10% stake in me I have raised £600,000 for my new venture, Central. So all is not lost!
My venture, Central, is a new kind of workspace. It’s for anyone who is out and about and wants to touch down to do some work. As with most of the things I do it is all happening at quite a pace, we open in just 12 weeks. So we’d love to hear you views on the concept. Please have a look at http://www.centralworking.com or follow us @centralworking.com.
The plan is 30 sites in five years, so I hope people will be kicking themselves for not snapping me up cheaply in 2010!
Hope 2011 holds good fortune for you all.
James
Congratulations on the new business James, and thanks for stopping by and updating us.
Good luck with the venture. My tip would be to think about whether you need some prestige place (perhaps disconnected from the main hub) that members can use if required to hold important meetings.
We saved a lot of money with my start-up a few years ago by having membership at Home House (Portman Square). If we met blue chip clients there, they rarely asked questions about where our offices were, and it dispelled the ‘two blokes in a bedroom’ concerns, even though nothing had really changed.
I’m not talking about deception, rather image management! 😉
You might also look at the Adam Street club near the Strand. I realize your offer is more utilitarian, but I suspect this meeting issue is quite common for flexible workers and there may be a creative way around it.
This article poses an interesting question but I have to say I think I would definetely sell a proportion of my future earnings for £1million now!! I currently run a blog where I document my attempts at making a million, while also seeing if it’s possible to make a million through the kindness of others! Although you’d be loosing potentially millions in the future, I would happily sacrifice 10% of my future earnings if I was given £1,000,000. This would be an excellent boost, and allow me really give my business ideas a good go!!