Latest / Talk Commerce / Cashing In On Your Company's Hidden Tax Gold: The TRA Revolution with Andy Lee
Transcript
- Brent Peterson (00:02.712) Welcome to this episode of Talk Commerce. Today I have Andy Lee. He is the founder and CIO of Parallax's Capital. Andy, go ahead, do an introduction. Tell us your day -to -day role and roles and tell us one of your passions in life. Andy (00:20.023) Absolutely, and thank you for the time Brent. Thoroughly enjoyed some of the episodes that you've done with some of your previous guests. So my name is Andy Lee, I run Parallax's Capital and I'm the CIO of the firm. And so that means I wear several hats, running from being sourcing opportunities, which is basically business development, to assessing opportunities, which is making a call if we're going to extend credit. and all the way to negotiating these transactions and structuring them. And so that's what I would say as it pertains to working in my business that I focus on. I seek to monetize tax receivable agreements, which are typically investment grade businesses that are publicly traded entities that were delivering upfront dollars to pre -IPO legacy asset owners of these now public companies. And so that's what I do. I live here in New York City with a young pup called Toco. He's a Corky. And I'm from the middle of nowhere. I'm from Champaign, Illinois. Brent Peterson (01:34.094) I'm not going to say it's the middle of nowhere. I mean, think Illinois is a great state and I enjoy going to Chicago, of course. I've only driven through Champaign. And I saw a picture of your dog. I have a Jack Russell. So we have somewhat of a passion. English passion. Andy (01:54.799) I was gonna say my wife calls it flyover country. She's from Los Angeles and living in New York. She's like, isn't that what they call Ohio in the Midwest? Brent Peterson (02:03.854) I always like to joke saying I'm in Minneapolis and it's the state there's it's a it's a city between L. and I mean between LA and New York All right, so before we get started though you have Volunteered to be part of the free joke project. I'm gonna tell you a joke All you have to do is give me a rating one through five. So here we go Andy (02:27.397) Awesome. Brent Peterson (02:29.238) I asked the surgeon if I could administer my own anesthetic. Sure he said, knock yourself out. Andy (02:39.554) Definitely a four. Brent Peterson (02:40.608) All right. Thank you. Thank you, Andy. All right. So let's dive in. You are young, which I'll give it to you. You're young. I'm not going to say stupid. tell us a little bit about how you got into what you were doing at such a young age. mean, it's amazing. Andy (02:52.238) And stupid. Andy (03:03.579) Yeah, so I'm from the middle of nowhere as I mentioned. I had the opportunity to go to college a little early. I went to college when I was 15 and when I graduated I was 17 and my dad, I had a job to go work in New York City and my dad was like, no, you're not going because I needed for rental consent to sign a lease in New York City being under 18. He just didn't let me do it and he was like, go get your PhD. being a young rebellious kid, was like, I don't want to do that. Unfortunately, because I couldn't sign my lease, I had to do it. So I did a master's. And I did a master's in taxation for three reasons. One, it was a one -year program to bridge me to my 18th birthday. Two, it had no coursework participation, so you didn't need to go to class. And three, it had an open book exam at the end of the year. So all you got to do is be really good at cross -referencing. And so I did that. Post that, I started my career at Citigroup where I had the opportunity to work on what I do today, which is in the monetization of a tax receivable agreement. And that was fascinating to me. I thought someone should provide third -party liquidity to the overall opportunity side, but it didn't take much of it. Went down to a private equity fund called Lone Star Funds down in Dallas, Texas, another middle of the nowhere place. And there I basically got to Andy the only way for you to get promoted is for you to create something. And I was like, that's interesting. And so there were a number of projects I worked on. The one that got a lot of laughs was that if you thought that drones were inevitable in our lifetimes, then you would try to buy all the air rides along the Hudson. And anytime Bezos flies a drone across, you would try to charge him a toll. Becoming an infrastructure of sorts. Unfortunately, Liberty State Park on the south side of Jersey City caused a a whole enamel investment thesis. And so that never got off the ground. What got off the ground was in the creation and monetization of tax receivable agreements. Seven years ago, the firm said, how much can you deploy into this opportunity? And I said, $150 million a year, thinking that was a big number. I feel like that's a rounding error. Andy (05:25.755) the firm has raised an access of $100 billion. And so they were like, look, why don't you go do it? We'll give you some money to go do it. If it doesn't work, I'll come back in two years. And so I left seven years ago. We've since raised six fund more recently, about almost half a billion dollars of capital. And it's been a journey. Brent Peterson (05:46.358) Yeah. Wow. Okay. So tell us, tell us a little bit about TRAs. I have to admit that I'm not, I wasn't familiar with them before I read a little bit about your bio. I know in our green room, we talked about EBITDA and there's, there's a lot of things that maybe entrepreneurs, some entrepreneurs understand, but also there's a lot of things that no entrepreneur understands. tell us about TRAs and, and maybe your target and why somebody would look at one of those. Andy (06:16.557) Absolutely. So our target audience, whenever we engage with sellers, are pre IPO shareholders of companies that have gone public for years ago. That's our core of ICP that we focus on and that we engage with. And what we do, think about it as for many cash generative businesses day one, think business services among others. might that be an accounting firm, a lawn mowing business? These are cash -reduced from day one, not heavily capital intensive. Unlike tech companies, they are able to stay as LLCs as sole proprietorships or partnerships among others. This enables them whenever they sell the business longer term, whenever they think about retiring among others to deliver the buyers of these assets. what is known from a tax perspective as a step up in basis. That's incredibly valuable to a buyer because that increase in basis basically reduces the amount of taxable income that they have on a go forward basis. not only like two businesses may have the same EBITDA, but may have very different taxable income profiles. A taxable income profile ultimately decides how much cash taxes that you are going to be paying to the IRS. And that's a core focus of many small business owners. I think the item that I might always share is that people always view the IRS as the boogeyman. But look, the US government is very focused on encouraging growth across the economy. And so putting money in the pockets of business owners is a core focus. They want you to grow. And so some of the items that that includes include the likes of allowing historically post the Trump tax cuts in 2017 for capital expenditure to be expensed immediately. That has gone down to 60 % today, but that's an incredibly valuable item to encourage investment in our economy. And so those are elements for a business owner that they should definitely work with their account, accountants. Andy (08:44.175) to better understand how can they invest in partnership with the US government to grow their businesses. Brent Peterson (08:53.518) Explain a little bit how that helps liquidity. know that in some of the notes you had, the TRAs will allow startups for a new source of liquidity. Tell us about that. Andy (09:06.563) Yeah, I would say it's less so startups. But to my point about they need to have been LLCs. And so their formation, when they formed the company, they needed to be in a pass -through format. That allows them for whenever they do go public to deliver to the public company a step up. And at which point of time they enter into with their lawyers a tax receivable agreement. All a tax receivable agreement is, is basically an IOU contract that says, Brent, whenever you generate tax savings from the IRS for the next 15 years, you will pay a portion of that to me. And so I basically step into the pre -IPO owner's shoes and say, Brent, instead of waiting 15 years for that annuity stream of cash flows, I'll deliver you dollars today. That might be valuable to you from a recycling of proceeds perspective, a simplification of your estate, or reducing brain damage altogether. And that's the service that we deliver to our sellers of these counterparties. Brent Peterson (10:21.954) So I think in our green room, we talked about a big commerce and that it's public now. So be pre -IPO, if you own that as an LLC, you would qualify for this? Or if you bought this on the IP, tell us a little bit about the journey. Andy (10:40.421) Thanks So we monetize it primarily from pre -IPO shareholders. And so if you are a pass -through entity, you went public, regulatorially, you would need to transform yourself into a C -Corp to go public, at which point of time you would become and deliver a step up to the newly public company, for which you would then be entitled to this annuity -like cashflow stream. and that's what we're monetizing. Brent Peterson (11:16.182) Interesting. Tell us a bit about the garbage men of private equity. Tell us a little bit about your idea of being impatiently exuberant. What does that mean and how does that impact you and your career? Andy (11:18.191) Think about me as a garbage man of private equity. Andy (11:36.367) Yeah, look, it's entirely from some of the reviews that I received back when I was a young analyst and associate in private equity where many of my mentors would be like, you are impatient to be great, but you bring such exuberance from it because I remember my first review after the feedback was given that you had a great year, they have any questions for us. And my first question was like, how do I get your job? And they were like, not heard that one before from a young associate and I was like, look, I don't mean this in a bad way but my job is to retire you and they're like, what do mean by that? And I'm like, I want you to have made so much money that you're just laughing to the bank and gave me your seat in return and I was and they're like, we can get on board with that. How do we make that happen? I was like, look, my job is like to put like put so much money in your pockets that you don't even care about this job anymore. And they're like, we're all aligned in that regard. How do we get there? And so for many of them, they're like, you bring such joy to the work that you do and such enthusiasm and energy and that's something that many fully appreciate. Brent Peterson (12:53.954) Yeah, I saw your rap video and tell us a little bit about your, maybe tell us a little bit about your personal, internal ideas or personal motivations to go outside of the traditional tax space from a promotional standpoint. Andy (13:12.549) So I think it's a little bit about, I think many people really struggle in that the product that they sell isn't the product that they deliver. And for me, like on a personal basis, that's something that I really wanna create congruence between. The product that I sell is the product that I deliver. And so as I think about the customers that we engage with, the employees that we're looking to hire, I want the experience that they have to be congruent relative to what we actually deliver them from a customer experience or an employee experience perspective. And what that means is that we don't take ourselves as a firm too seriously. We're willing to put ourselves on the edge to experiment. And I always tell my team, we're not afraid to fail. If we're not failing, we're not trying hard enough. We don't expect a bad hundred. Like I don't expect you to get everything right. our job is, and if we're getting everything right, it literally means that we're not taking enough risk. And in the investment business, we're effectively pricing risk. Like my job is to deliver a return to our investors and ultimately, would they like to have it all in a uniform manner? Yes, ideally, but that's not oftentimes how these things come. Some deals are larger, some deals are smaller, some deals are have different risk profiles than others, my job is to deliver an experience which is congruent relative to what we shared and sold. And so for many of our sellers that we engage with, the road avenue through which investment management is engaged with them is via news articles, educational content, content strategies, others, unlinked. But no... I always tell people it's what is it something that they're not willing to do? Not many of them want to look like fools. I'm like, hey, let's put ourselves out there a little bit and maybe look a little bit foolish. But as a result, people are just like, this is a funny group at worst. Like, they don't take themselves too seriously. They are willing to put themselves on the edge and that's something that people appreciate. Andy (15:35.469) And so that's an element that I think is congruent relative to my own personality and trying to build a business in the way that I want to be experienced at myself. Brent Peterson (15:46.882) I want to come back to that. But first I want to just ask you about how entrepreneurs, how investors should be making sure that they have enough education to know what they're getting into. What are your recommendations besides following you, of course, what are your recommendations on how people can stay educated about what is out there as an investor and as an entrepreneur? I think it's even more important. to at least know about all these things, what kind of resources would you point people to for that type of thing? Andy (16:22.907) So I would say a number of things. Instead of being a know -it -all, want to try to strive to be a learn -it -all. And there are elements to your business. I recognize that working in your business is a very important and critical element, but working on your business is even more important. And so like every month, I think about various segments of my business. And so, This month, it's our go -to -market strategy. And I've spent time reading a bunch of go -to -market books, listening to a bunch of go -to -market podcasts in order to understand how I can grab strategies and tactics from other industries to employ in our market. And that's not to say that they're all going to succeed. majority of them are going to fall on their face. But I just want to see an experiment to understand how they all, if there's any efficacy and application to our business. And so I would say first and foremost, being a learner and be not being afraid to fail and see like being focused. Look at it from the perspective of if I wanted to make my business more systematic and programmatic and remove myself from it, there are just investments that I need to make. And that's an investment of working on the business, not in the business. And to be clear, that's the tyranny of the urgent versus the important. Working in the business is the urgent, working on the business is the important. Brent Peterson (18:05.516) Yeah, I think that comes out of the book Traction and I'm a big believer in EOS, Entrepreneurs Operating System. I know there's a ton of frameworks out there for how businesses are run, but it does give you some discipline around that. One of the things, just kind of keying in on that, one of the things that we talked about yesterday in a meeting I was in was like ad backs in terms of your EBITDA. And he gave the example of installing an ERP system. which may cost say $300 ,000, but it is an add back in terms of this is a long -term investment and it's gonna benefit the business in the future. How do you advise clients that don't believe in that or they're not quite understanding, this $300 ,000 is gonna come out of my pocket this year, but it's gonna add value to the business in the long term. Andy (18:59.493) Look, it's always painful. Change is painful. And it's the question that you need to ask yourself. Are you in a season that you are prepared to change? If you're not prepared to change, don't worry about it. store it as an option. But like if you won't like that, you're not in a season like that you want to change. Don't worry about it. But if you are in a season where you are prepping your business for sale in the next five years, ask. Go reach out to private equity firms and understand what they want to buy. They don't want to buy a business that's run on QuickBooks. They want to run a business that they can trust the source of truth in the accounting programs. They also want to understand that you have processes and systems that they are stepping into, not ones that they are going to have to build. Because if they have to do that, that creates a significant amount of brain damage. that they're gonna have to engage on and building that is just gonna require an incremental amount of risk to them, amount of time and effort and dollars. The more you can de -risk it for them, the more people are willing to pay for your own fundamental business. And think about it as your own life. You wouldn't want to buy something that required a bunch of brain damage to work through. You wanna buy something that is... easy to buy. You want to buy something that's easy to understand and use, that you have a predefined process to execute upon. And so I think the book that you just suggested, Traction and the Entrepreneur Operating System, are critical elements to that. Brent Peterson (20:44.632) Yeah, I like what you said. One of the other things that I learned or was one of the things I learned yesterday was looking at your cashflow over the next year, you can see two businesses that might have the same cashflow in a year, but looking at it broken down, you might see that there are some spikes or some big drops in certain times of the year that may have an impact on that business going just the day -to -day operations. That would then of course in turn affect the amount that the business is worth. How much does tax have to do with that? Andy (21:24.731) Absolutely. Look, I wouldn't be a tail biting the dog situation, but one should always understand what are the impacts for tax. look, Uncle Sam wants to be your best friend. They want to get their fair share of taxes to support infrastructure, social security among others, but Uncle Sam wants you to invest in your business. And so there are items that many business owners are reactive to. they see the amount of taxable income they're going to generate in a given year. And they're like, how, what, they should be thinking about what investments can I make? Can I pay for that ERP system right now? Before the year end, thereby reducing the amount of taxable income I have this year, but also making that big investment in my business. And so understanding the options is a critical element as you think about your business, because like you can take 300 ,000, like, depending on your cutoff and the given year. If you want to make that investment in 2025 anyway, why not just pay for it in 2024, reduce the amount of taxes that you might pay and just defer the tax by a year. Those are all elements to strategic tax planning that a gutful accountant can help you around. Brent Peterson (22:45.166) What are you excited about coming up now? Do you feel the tax situation in the US is going to dramatically change next year, not knowing what's going to happen in this next election? do you think that, I mean, I think one of the interesting things, stats I saw was no matter which, who's president, which party's in charge, everything, we're still growing, right? Is there certain things that maybe people should be doing now or? are people sitting on the fence. Andy (23:16.313) Look, I think the biggest barrier to any investment is always uncertainty. So the more certain you are of the business environment, which is inclusive of the tax situation, you're more willing you are to invest. And so there are certain items and statutes that might get grandfathered under a new administration, or there are statutes that may expire and that may not be reenacted. in a new administration. And so those are elements and risk profiles that one should assess for their personal situation. What risk are they willing to take and the impact upon their business. The elements as it pertains to the environment obviously are a number like you need to be able to have confidence that the economy is going to grow for you to make an investment. Otherwise, economy that is going downwards, you might buy this new machinery that would never be used because there's no demand. Those are elements to a specific sector, specific opportunity that one must be thoughtful about. don't know if tax would be, I would say tax is somewhat at the tail wagging the dog in that instance. Brent Peterson (24:32.078) Do you have a sector right now that you're impatiently exuberant about? Andy (24:37.403) I think the tech sector for the longest time has been an aduldrum for the better part of the last 24 to 36 months. Life, business is cyclical in the same way that people are cyclical. Like I haven't seen some of my friends who have just given birth to kids. That's nothing wrong with that. We're still really good friends. But now they're in a season of life that they're not going to be investing in our friendship. And I get You need to figure out for yourself what season of life is your business in? Do you need to harvest cash from your business? That's one way to think of it. Or are you in a season of life where you have enough and you want to be investing in your business in order to grow its enterprise value such that when you want to sell it to someone or you can give it to your kids in a better place. Those are all inherently challenges that one needs to figure out in time. Brent Peterson (25:34.092) Yeah, I guess one last stat I'll say from my learning and I like being a learn -it -all instead of a know -it -all. I'm certainly not a know -it -all, but a learn -it -all is a great thing to strive to. All the options you get as a business owner, if you're filling more of those boxes in the ESOPs and the different ways of maybe selling your business and funding your business for a sale, And they gave an example of a family business that has enough cash flow to give the legacy owner enough income on top of funding the business into the future. What is your thought on how people could best position themselves in not only a tax situation, but in a business situation, both as an investor and an entrepreneur? Andy (26:29.563) Two different things, right? An investor is very focused on the future value of a business. And that's an item for an entrepreneur who's working in the business. He's trying to figure out for himself, how does he make the business run without him or her? But also how does he make the business more more resilient? And those can be congruent and get good. Those can be incongruent all at the same time. You just need to figure out what your objectives are because your objectives ultimately dictate the actions that you take. So an example of something making more resilient is installing an ERP system, that inherently risk and returns associated with that. are a bunch of public companies that have seen extreme price declines in their stock price because their ERPs went south. And when your ERP goes sour, things don't get delivered to your customers, bills don't get paid, and voices don't get collected. And that's terrible. Are you in a season of life to make that investment? Because it's not just an investment of dollars. It's also an investment of time, effort, and money. And so those are challenges that and risk assessments that an entrepreneur has to make that is somewhat the void of the financial return and risk associated with that of an investor. But you're ultimately, and I always tell people this, a return on your equity is incredibly important, but so is a return on a, your effort and a return on your time. Those are inherently the only non -renewable resource in life is time. You'll never get it Brent Peterson (28:19.458) Yeah, thanks for making that distinction between the owner and operator. I wasn't super clear in that. Andy, we're speaking of time, we're burning through time quickly here. As I close up the podcast, I give everybody an opportunity to give a shameless plug about anything they'd like. What would you like to plug today? Andy (28:41.669) I would say that Uncle Sam really wants to be a positive contributor. I know many business owners have a negative notion as it pertains to the U .S. tax system, but Uncle Sam really does want you to grow and he really would do want you to build your business and he wanted you to be a resilient business. One that provides for gainful employment in your local communities, but also one that gives back. Might that be funding your local sports teams, little leagues among others. And so there are many avenues for you to have an impact, not just in your business and the customers that you engage, but also your community and stakeholder at large. And so I would seek to find this partner with the silent partner being the US government to find avenues through which you can be an increase your impact of your. your 24 hours you have in any given. Brent Peterson (29:43.374) That's awesome. And how can people get in touch with you? Andy (29:47.339) I'm active on LinkedIn, so I would love to engage with you and your listeners on that platform. Brent Peterson (29:51.95) Perfect. I will make sure I get all to the show nuts. Andy Lee, it's been such a great conversation. Thank you so much for being here today. Thank you. Andy (29:57.231) Thanks for your time, Brett.