Is Private Equity Optimizing the Business or the Playing Field?

Private equity loves leverage, but their best leverage might not be debt, it might be politics. Today we're asking, does private equity just optimize business or does it optimize the playing field itself? Hi, ed. Hi Rory.

Hello. Good to see you. Thoughts on this topic? Help set the stage here.

Well, nothing moves without the bread being buttered on a certain side of the bread. In this world, we know that. So influencing public policy is, uh, is imperative in business no matter what Yeah, I think the, the other piece is private equity folks I. exceptionally one sophisticated and two, um, in control of a significant amount of money.

They have, they move a lot of the economy in the small mid-size business, so you know, the 5 million to $500 million revenue type businesses. That's, Yeah. chunk of that, which also contain a lot of employees, which also means a lot of voters. Mm-hmm.

so the, the ability they, they private equity owners will carry an outsized weight certain policy. People, depending on what the, what the issue is, and whether it's kind of a student body, right, student body, left, like all of private equities go in Yeah. or they're gonna lobby really hard for certain changes to laws, regulations, et cetera, that might impact a portfolio company or Mm-hmm. And that's Yeah.

at the end of the day, the private equity guys may or may not be really care about that, you know. Flounder that's, you know, in some endangered, endangered flounder in some bay somewhere. But they will care about the fact that it's gonna impact their return. Yeah.

Or their carried interest. really about, yeah, it's really about the, it's really about the money. Now some of, some of the most famous. Folks that are involved in politics, so like a Peter Thiel for Mm-hmm.

Yep. off in venture private equity and has now expanded That's a good point. into politics more than even on the investment space. So it's, it's constantly, it's constantly going.

But the, the one thing to keep in mind is private equity will always pull the tools out of their tool bag that they have available to them to make sure that the. Portfolio companies are fixed and get the highest return, and one of them is lobbying politics, public policy. That's a critical, critical it's not just we're responding to regulation, we're actively trying to shape it. Yeah.

absolutely, Okay. that's right. Actively this, this, like you mentioned like some industry pieces, but it could be, um, like fee structures or loopholes or, you know, different well, you, I mean, Rory. Rory just mentioned the kind of, the famous one Yeah.

So carried interest was like a big deal in the 2016 presidential election, and amazingly nothing ever happened. Now carried interest is essentially the return that the, the private equity folks get. It's the cash they get paid at the time the the investment sells. Now they have, as generally a $0 investment, zero basis in that carried interest.

when they get paid, it doesn't come in as ordinary income, even though they. We're basically, it's a return. They didn't get a return on any Yeah. It was actually on labor invested, which for all the rest of us, is taxed at ordinary income rates.

Yeah. For private equity, it's taxed at long-term capital gains rates, Yeah. which means you have a, Seven. up, 'cause if you have zero basis, you can't have losses, so you only have capital gains.

They're all long term, which are, which are taxed at, in some cases less than half. Yeah. what the federal ordinary income TA Yeah. tax rates are with Yeah, funnily enough, that is not the, uh, top thing I remember from the 2016 election carried interest that was top of the headlines, Yeah.

um, in my mind, but Okay. So, and then you said it was like a famous, uh, a famous example that Rory mentioned. Is there like a particular regulation that goes along with this that, Well, it really, it's, it's what Ed talks about is the discussion of whether it gets taxed a certain way. oh, okay.

point, the difference between long-term capital gains at, at say 23 to 25%, depending on some state No. Okay. lumped in there versus like just as a lump sum, perhaps 40%, uh, on ordinary income. So you can think about those rates being applied.

On very large sums of money. You're, you're talking about ultimately massive amount of, um, taxation difference based on the treatment. And, you know, as these things go, policy changes are what actually make things, you know, different or in this case stay the same. Right.

We wanted, they wanted it to stay the same. It stayed the And is, is this at the firm level or like individual? Like individuals. No, it's, it's, it's basically a, it applies to, um, overall business and the characterization of, we we're turning this into a taxation podcast, which I'm really out of, over my ski, which I'm really out of, over my skis on this would be all Ed, basically.

But basically like, know, the, the concept of, uh, you know, uh. carried interest as long-term cap gains is under it. It's just debated because as Ed said, is it really an investment if you have no investment in Um, And investments are what, what our, what our tax with cap gains as opposed to a salary or other income. That's, you know, current if you will, and not risk based is tax, is ordinary income.

So, uh, treated, it is how'd I do on that? a zero basis. So Okay. a bonus, Yeah.

really it's a bonus It is. Yeah. business. Yeah.

that's the, But it's, but uh, And, and because of continued lobbying and direct and indirect ways in which you influence that, you've, you've beaten that, you know, attack off from the other side that says, no tax the shit out of it. It's not, it is, it's just compensation. It's not okay. So they'll, they'll like.

But, but they managed to beat, you know, kind of, uh, beat that one. is, is that allows private equity partners to be, give to bipartisan support, to Yeah, support, to make this die. that's Hmm. Okay.

So they'll basically fight because. bringing, bringing the nation together is really what we're Private equity brings America together. That's the headline of this episode. Um, through, through debates about tax characterization.

That's, that's pride and true from founding fathers. That's how we do it. Yeah. Um, excellent.

So is it like, this might be a way in, is private equity, is it like buying time rules and options? Uh, the concept of buying things there, um, not so explicit. I mean, there's there's many different ways in which private equity industry influences policy. Yes, you make political campaign donations to, but Ed's point.

You know, oftentimes you're making, making it to bipo, bipo bipartisan channels, so you're not just like, you know, pitching to one side, you're, you're spreading it out. But also through, um, there's something to be said for being subject matter experts, right? When policymakers are. Um, you know, coming up with legislation and other regulatory changes, they look to industry experts to help guide that.

So, you know, stalwarts and the private equity industry, you know, they can be considered that. And I think Ed covered it a little earlier and then we can dive into this little later, but sector specific. Regulations and policy changes, then you bring on, you know, people that are very well versed in that specific sector as opposed to just private equity. But the point is, having somebody that serves as either a lobbyist or supports lobbying, um, is a way in which you make that influence.

And we all know how things happen in dc you know, that's why lobbyists are like, that's their headquarters, if Yeah. Like, is Okay. in, in, in ways to, So we have this concept of pe actively shaping policy. And they do this through things like coalition building, lobbying, Yep.

um, writing letters, I'm sure a a million different, uh, tactics they have. And then are there certain hotspots or flashpoints, I'm imagining like healthcare, things like housing are always kind of this, this is like personal emotional stuff. And Yes. enters that realm, what happens?

Well, let's, let's tie it back to. What, what are the thing, what, what is the ultimate goal here? I think we touched on one big time, which is taxation and that, you know, that's a big one. But another one is about transparency regulation within the businesses that these, um, private equity entities and their manage and their operating companies, you know, uh, you know.

Are involved in. Right. So healthcare would be a, a great example. So changes that would, would create more regulation in healthcare, which we know is a big area where that is, you know, at the forefront.

Like it could stifle business, it could raise costs, it could increase the, um, it, it could decrease efficiency, it could do all these things. So you're constantly looking for ways to. Um, keep your costs lower to be more profitable, to reduce the regulatory burden of, and transparency and things like that to make your life easier and less Yeah. So any, you think about it in the big picture of just stimulating commerce and making it as, you know, lessen the red tape, call it.

And so there's so many ways to address that. So many industries that you hit on a great one. Healthcare, that's, that's big and private. Equity's huge in Yeah.

And, and is it like, it's private equity, it's not public, so like disclosures and things, SEC regulations are, are different. And private equity goes like, it's different for a reason. Yeah. I think the other, the other piece that you tend to see is the, it isn't all one direction, Mm-hmm.

you have some elements of. equity. As businesses mature, lobbying goes a direction of, okay, can we put regulation in place to kind of protect our Right. Good point.

Good point. in earlier stages or you've got kind of more greenfield opportunities, they go, can we broke that down the walls. Now that we're infiltrated, we wanna bring, put 'em back up like, Then it comes back to, okay, can we put in regulation? yeah.

again, it's not what I, what I. I don't mean to say is that they're absolutely Machiavellian and they don't care about policy per, you know, kind of doing good work for good people and, and good things. Having said that, the, the, the Specifically disclaiming that. Yeah.

Their number one priority is to get a positive return on investment for their shareholders or for their limited partners, and therefore will act in the best interest of the limited partners and therefore the portfolio companies in supporting or opposing. Certain regulatory policies, lawmaking rule, you know, lawmaking, rulemaking, et cetera, at the state, local, and national level. That will help their portfolio companies do better and get a higher return. And sometimes that.

Is, and, and people tend to think of, like these business people, they always just wanna, you know, gut the government and get rid of regulation and cut taxes and no, what they want is a better return. And so there's this economic concept called rent seeking, where essentially what they do is they go, Hey, we're gonna go in and get the government to essentially put obstacles in the way of our op, uh, of our competitors, so that we get. Outsized returns thanks to the government putting these non-cost to us, Yeah.

obstacles in place. And so that's what they're, they're, so that's the, Or grand So, so the two things are, um, fees and what was the other thing? Sorry, there I, it was my head. And, um, regulatory burden, either creating it or knocking those Like the biggest thing for them is like their return.

So anything that affects that and like fees are a huge one, which is why the carrot interest piece would be big. Um, but as I think about this, I mean, we've talked about some strategies like acquisitions and roll up strategy, so it might be regulations around what you can do and what you can't do with, with acquisitions or roll up strategies. Okay. Antitrust is a big, is a big one.

And, and I think if you, now, this isn't always private equity that's doing it, and so you get kind of, a lot of times it's the, the business community or a specific sector is moving a certain direction and private equity is either, and again, I'll, I'll take an example. We, we were involved in, Rory and I were involved, actually all three of us were in a company where regulation. In like Yeah. the business, and so it created the business opportunity and we essentially had a monopoly because you had a, Mm-hmm.

you know, kind of a, an oligopolistic market that was being regulated by the eu. And so you're like, okay, and then we solved this, we provided the solution and got everybody to say, yeah, you're good people. As Yeah. you know, we worked with like Interpol and Ice Yeah.

other, and all these other folks, so that. You know, at the end of the day we were like, everybody was like, no, they're good. And there wasn't any intention for, for anybody to come kind of rolling in. Well, we, you know, that's, there's a lobbying effort there to, Yeah, there's no intent to have regulations reduced on exactly.

stuff online. You know, put it, make the bar higher so that we have more work to do. and then to your point, once, once this company got in there and it was, I think at the time it was a duopoly, it was one other business that was. In the same ilk of the company we work for.

But then subsequently, once you're in, you don't want them to let others in too. So the lobbying effort is around why we specifically were superior, and you'd be, you'd be wrong regulators to let others in, right? So ultimately, that that wall did come down. And so the burden of, um, you know, the, the, the burden to become part of that group, um, you know, uh.

Went, went away. And so then you had to like separate through innovation and stuff like that. But anyway, very interesting way to think about that. because of lobbying.

Yeah, exactly. Yep. 'cause it was a, you guys are, you guys are a monopoly and you need to allow other other companies to do this same work. And that was an EU driven, yeah, driven essentially.

exactly. are PE firms doing this on a one-off basis or is there like a coalition of like PE firms that they go to a lobbyist and say, we wanna push this forward, or we wanna retract this part of the regulation? And Yes, both. Yeah.

all of the above. I think what, what you'll tend to see, Yeah. um, is industries have their industry lobbying, Mm-hmm. that you know, essentially are.

You know, you've got the, like Rory and I used to belong to the Debt Buyers Association. Rory probably still does as a matter of fact. And, uh, because, because of the, Yeah. and Mm-hmm.

Mm-hmm. part right. the dues you're paying is for the lobbying efforts of the Debt Buyers Association in order to be able to kind of deal with the Consumer Financial Protection Bureau and all these other folks to try and get the regulations so that you could collect and get a good return. The, so.

The predominant method that most companies will use. And I think private equity is no different. 'cause really they're a proxy for their, for their portfolio companies. And they may have portfolio companies in a portfolio that are at Yeah.

Yeah. positions Yep. It's really, it's the, they, it's, it's the look we recognize we need to be part of these, these industry groups or industry vertical. Um.

Organizations that do lobbying, and so there's support there, but at the private equity level. So how does private equity interact? How's it regulated it now that it's part of 4 0 1 Ks? Where do you think some of that lobbying came from?

You know, those are the kind of things where the, where the, the private equity groups are going to lobby. Kind of in club or individually to get that stuff done. And then don't discount the fact that you've got folks both in portfolio companies or where portfolio companies have an established lobbying relationship, or you've got, you know, like a Blackstone or or KKR, they will have lobbying teams that staff. Yeah.

kind of. Focused on specific, specific areas and have relationships on the hill and locally at the state level with folks that they need to have those relationships with. There's a lot of. Yeah.

Well, and we talk about lobbying as a means to accomplish your ends, litigation's the other way in which that occurs, right? So once there is something in place and you know, you don't have an active means to overturn it through policy changes, you litigate to then get the interpretation of the policy Hmm. set precedent and hopefully do that in your favor. So, um, that's also why there's a lot of lawyers out there that make a lot of money too, because.

Um, through litigation, you can, you can influence policy by how it's interpreted and then enacted so Who, who or how decides, like amongst the PE lobby group. Okay, we think this will be most beneficial for private equity, or at least, at least this, like our kind of private equity. Um, and let's move, let's go for this one. Or let's, uh, attach, you know, this element to this bill or whatever, who decides like exactly how to do that.

I think there's a lot of cooks in that kitchen, right? You have, you know, you have the fund strategists, if you will. Uh, you have the LPs and their interests, which are always at the forefront, right? So, um, you know.

Uh, we keep using the, the taxation piece, but that's, that's clearly one that's easily applied to all stakeholders. Right. But, um, who helps them influence? Well, you have analysts, you have, um, people on the hill, lobbyists that, you know, kind of become part of the, um, equation to help you formulate your own policy that you then want to have enacted or, or pushed, what have you.

So it's like there isn't one. Person that owns it. It's really like the industry and or, um, maybe if you have a big enough fund like Blackstone or something like that, it, it really is kind of like the, the key key leaders, board members, um, LPs most importantly, that kind of influence that. And you come up with a plan and just like any other business, uh, bus business, um, goal, you know, you try to accomplish it through actions.

Yeah. How does someone, um, pay attention or keep tabs on this? I mean, I suppose it depends on where you sit. If you're an employee in a portfolio company that's PE-backed, I mean the, the labor, you know, laws and regulations might be most pertinent to you.

If you're sitting in like an LP seat, that's much different. How do you kind of keep tabs and make sure like, hey, like I, I'm aligned with, with that interest or that move or not. That's a good question. I mean, this is highly wonky stuff, so I'm not sure the average employee's about that per se.

Um, you know, I think, look, there's so much information out there that you can gather and for through any means. So I don't know if there's just one way to do it, but if I, if just, you know. Keeping tabs on things that matter to me. I, I set up feeds on things that, you know, apply to it and, you know, have that hit, hit my algorithm and serve it up to me so I consume it.

You know, just like, like anybody does these days. I think there's, there's a, there is an element of the, the technology piece, but I think more, more along the lines of most folks don't. And it really is a part of the value. So you kind of talk about how do you align, kind of, how do folks align in these groups to be able to get certain policies.

And in a lot of cases that's, you know, it's their full-time job. Yep. so when you've got lobbying organizations, you have, like K Street in DC is lobbying, I mean, and are law firms that do lobbying and you kind of go, okay, that's, that's who I'm gonna work with. And I'm, you know, and they talk through it and the, the lobbyist job is.

If you talk to a lobbyist, and I've talked to plenty of them, I never have actually, believe it or not. Yeah. the, the, they will tell you that their job is not, is not to kind of get this done or that it's to educate. Their job is to educate and their job is to educate both directions.

So it's really to go, okay, Yeah. happening in DC or this is what's happening in Olympia, or this is what's happening in Albany or Sacramento, and so here's what's going on. And then they translate that back down to and, and some of 'em use like. Some of the big ones, you know, I like, I I belong to a couple.

And so you've got ones like SHRM for instance, that are like, Yeah. they're Society for Human Resources Management. They, they've got Mm-hmm. and you know, they'll go, okay, here's the latest of, you know, legislative updates and this and that and the other thing, and it comes floating down to you and they assemble it.

And then so they're educating down to their membership going, Hey, here's what's going on. And then they have the education up to the. To the policy makers, whether those are, you know, the regulators or the, the, the, uh, elected officials that go, and here's what that policy, if you pass this or I see that this is proposed, this is what it's gonna do to my constituents. And so let me educate you on the impacts and really.

The, the system. And, and again, that's one of the reasons why there's things like open meeting laws and public hearings is, is really to get all that stuff out in the open and allow the lobbyists if they're, you know, and again, they'll tell you this is exactly what they do, is to educate up and down the impact so that, that way it's best positioned now that education generally will come with a and therefore. Mm-hmm. can you do it this way or this way?

Or we, we see what you're trying to do, but you know, we need these different approaches in order for it to be really successful with our constituents. Or have you thought of X? But that's a, a good lobbyist is truly an educator first and then gotta move their way through it, and they educate up and down and it part of that. What is our position gonna be like for, you know, the, the Semiconductor Manufacturers Association?

What's our position gonna be? It's really the lobbyists pull that information together and then at their meetings they go, Hey, here's what we're thinking. Here's what's going on. And then the boards of those, which generally belong or memberships kind of go, okay, yeah, let's go that direction, Hmm.

be our legislative priorities for this Mm-hmm. Yep. What else should people know about this? I think the important thing for my C is there's nothing nefarious about it.

No, wrong with it. As a matter of fact, it's a democracy in action, that's the way it works. goes, oh my God, the lobbyist. It's horrible.

It's terrible. No, this is, like I said, I, I do honestly believe that most lobbyists view themselves as educators, so it's not a nefarious thing. But the private equity folks will utilize the lobbyists in order to protect their interests, improve their return, really take, take their portfolio company to the next level. That's, that's what they're charged with by their limited partners, and they're gonna utilize all the tools in their toolbox.

And that's one of the, that's one of the tools that they're gonna use. And, you know, but don't look at it as it's an evil thing. It's a, it's a, it's democracy in action. And you know that Well, you said they're using lobbyists to pursue their interests.

Like that's anyone. Yeah. Any, everyone does that. That's how it works.

You would be silly not to. It was being smart, so, um, okay. Okay. Exactly.

Yeah. Rory. it's, it's not really any different than the way any other industry does it. You know, there's maybe, as we talked about, some specific areas that matter more to private equity than you know, agriculture.

But, you know, the way in which change happens is, is as we just talked about, through this process of, uh, education and, uh, influence in various ways and, and action. So direct and indirect. Has there any been, uh, like a famous flip flop where it's like, oh, they wanted this, and then right away they wanted the opposite. gosh, one I could, I can think of that's a good question.

The social media companies with the, don't want to have any regulation. Yeah. And then they came back as you got the big boys, like the Facebooks and whatever. We're gonna put in policies and we're gonna put in committees and we're gonna have Congress try and put in some regulation on Hmm.

And again, that was for my seat. That was one of those. Look, we want to, if we can do this, the higher the regulatory wall. Mm-hmm.

more difficult it is to scale. so the, the smaller, smaller upstarts are gonna have trouble getting into our industry now that we've established ourselves and we have the resources to meet these new regulatory requirements. So let's push for that. So initially it was, don't regulate anything.

We need to have a wild, kind of wild, open, crazy, whatever, and we shouldn't be liable for anything. And then it became a, no, no, no, you need to regulate this, which then creates barriers to Yeah. Yeah. that's the one that, you know, and that was kind of that, that, you know, 20.

2020 to 20 22, 20 23. That was like the biggest one where the big, the big social media companies kind of flipped and some of the big kind of, uh, Yeah. on a, on a venture side flipped on on those policies. Yeah.

The other one is, that's a really good question, and as I was talking about that example, the one that popped in my mind was banking, right? Like, so banking is one where it's so still. So old school that, you know, um, banks are holding their positions so strongly in the requirements and things like that to hold off the non-bank alternative lenders and sort of, um, you know, for consumers and the like to have access to financing other than like, bank loans and credit cards, so fintechs and things like that.

So the, the to, as Ed said, to put up more regulation, to make it harder to get a. A lending license, uh, nationally, um, which really makes it a lot easier to take on deposits. So you lose your cost of funding, all this thing and the other thing. So yes, once you're in, you're trying to, you're trying to put up a moat.

And banking is such the old school, uh, way of running the economy through. Um, you know, lending and deposits that's like, it's still here because of that, you know, because of the So like the government's bailed the shit out Yeah. for years now. So it's like the government supports that too through that.

So it's, it's wild. So, you know, we'll see, I'll be on this one. Maybe we have another podcast 10 years from now to see where the financial system's gone, uh, from where it is today, which has gone quite a ways from where it was 10 years ago even. So cool.

All right. Some, uh, lightning round exit questions for the group. Oh yeah, let's do it. public policy and like rule making were a sport, what would it be?

Uh, wouldn't, it doesn't, don't. Cricket matches go for like Yes. as opposed to like, um, you know, uh, a really quick match. So I would put, I, Okay.

I, I like, I like that. I was thinking more like Greco-Roman wrestling. Where, I like that too. I think cricket's better 'cause it's.

It's lengthy, boring, and there's a Yeah. There we go. getting thrown around Yeah. hard to follow the Throwing your weight around.

Okay. Um, yeah. That's a good if carried interest were named, honestly, what would it be called? Hmm.

Profit share. It's what it is. bonus. Yeah.

There you go. Yeah. Getting really specific. Good point.

Yes, Is, I'll see you in court. The most American sentence. Ooh. Well, I don't think it's necessarily like a Mongolian sentence, so Yeah.

I mean, I would say very American. Yeah. I think I think that, or it, it's definitely more American than anywhere else, but I Yeah, classic American with an FU before that, and then I'll see you in court. We're a very litigious society.

We just are like a built on it. I'll sue you. are, gonna sue you. we could Yeah.

podcast about my, my thoughts about how to Oh, okay. I Future topic. All right. Uh, let's see here.

We loosely connected to PE and we can make it happen. Yeah. You are forced to work in DC for one year. Are you a lobbyist, a regulator, congressional staffer, journalist.

Well, I'm gonna play for the Washington Capital's hockey team, but, um, no Yeah, I'm a, I'm a lobbyist lobbyist. Yeah. are an educator at heart. Okay, that works.

Okay. so I, I, I think I would, I would go in there as an educator and I would be an effective lobbyist. I, on the other hand, am a schmoozer kind of, uh, and so I would do it from that angle. 'cause that's the one thing we didn't talk about lobbyists.

This is they're educators, but you are a relationship builder. That's what you do as well to be able to, to, to be able to get a seat at Okay. table to tell that story. Yeah.

I mean, they have their connections. They gotta build those relationships and keep 'em up. Yeah. Yeah.

all right, last one here. Uh, we talked about like disclosures and transparency. What's the funniest thing they'd accidentally reveal in a disclosure? Like if PE had to go like, okay, here's everything Whoopsies.

Now you can see that I. Oh my gosh. I'm trying to concisely talk about how the sausage is made, but um, yeah, I think the LP agreements would be pretty Oh, interesting. Okay.

Yeah, I was gonna say, I was gonna say that, that or um, um, partner compensation. Oh Hmm. There you go. yeah.

Yeah. Yeah. At a public company, your top employees have to be disclosed, or comp plans have to be disclosed in the, in the DEF 14, in the in the proxy Mm-hmm. Nothing like that in private equity.

And that might be an interesting thing, especially for the Good point. Interesting. Yeah, we, we always get to hear how much Jamie Diamond makes every year. And it's a lot.

A Yeah. But, you know, talk about private credit. Private equity. Jamie's a piker Well, I was thinking, I was like, what's the equivalent question to, like, I remember I would have to approve expense reports and some of the, like I saw the wildest shit on expense reports.

I'm like, you can't expense that. Um, ed, you and I had, well, like a fa, like one dude tried to expense hair gel and I was like, no. No, heard of we're not expensing your hair gel. Well, I've, I've And also why is your hair gel $72?

Like what are you putting in your hair? Um, alright. Alright. Yeah.

Crazy. Rory. Thanks big rigs. Thanks.

Sweet Eddie. BI.