With President Joe Biden nearing his 100th day in office, his administration's economic policies have begun to take shape. The latest episode of "In Visible Capital" takes a closer look at what Biden's plans could mean for the private equity and venture capital world, including changes to tax policy, how his infrastructure plan could impact investors, the renewed push for financial regulation and a possible clampdown on the world's tech giants.
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TranscriptAdam Lewis: Hello, and welcome back to PitchBook's "In Visible Capital" podcast. I'm Adam Lewis, a reporter for PitchBook News.
Alexander Davis: I'm Alexander Davis, editor-in-chief of PitchBook News.
Adam: As President Joe Biden nears his 100th day in office, his economic policy has begun to emerge. On today's show, we'll cover what Biden's plans could mean for the private equity and venture capital world, including changes to tax policy, how his infrastructure plan could impact investors and his renewed push for financial regulation.
Alexander: All right. Adam, why don't we jump right in and start with one of the meatiest topics for the private market investors and big firms, and that's the capital gains tax, since it does have a great deal at stake for whether you're a private equity investor or a venture capitalist? The question is, what are the chances that this is actually going to be reformed and that these investors will lose their loophole, basically, where they're taxed at a lower preferential rate? Under the Trump administration, it was talked about, like other administrations have, including Obama, but nothing much really happened, even though Trump did complain a lot about it. What do you think on the PE side, in particular, what they're saying?
Adam: Alec, you brought up a couple of really good points that are just in your question alone because politicians have been talking about repealing parts or all of the capital gains tax really going back decades, and there hasn't been much movement in that direction over that time during Donald Trump's administration. Trump actually complained a lot about what real estate investors, ironically, and hedge fund investors could get away with capital gains. They did change a mandate that made private equity firms hold portfolio companies for three years instead of one before they could get the long-term gains treatment, which is around 15%, so that was some movement. Now, Biden campaigned on possibly a more robust fix to closing the loophole. That would mean that these taxes would go in at the income level for private equity and venture capital investors, which is -
Alexander: A much higher rate.
Adam: A much higher rate. That's looking at 37%, plus if you're in California where there's a state tax as well, they would be dealing with that. It's not at the top of his agenda. Obviously, they're still trying to push out vaccinations, and the plan right now is to push really hard for this infrastructure package, which did not include closing the capital gains loophole, which some people thought it might have in there. Short-term, could there be a proposal? Maybe, but, in the near term, we haven't seen that yet.
Alexander: There could be, and I think there already is going in some pressure from some Democrats and Congress to see some action, right?
Adam: Yes. I've been covering private equity for four and a half years and I would just ... No way of proving this, but it feels like that there is more attention on the private equity industry and more pressure in a lot of ways than there has been before to reform some of their more, let's say, controversial investing practices and some of the preferential treatment that they get away with. It's an easy thing to point to, "Let's close the capital gains loophole; let's make investors pay what the average middle-class person making $50,000 a year at least pay that in their income tax."
Alexander: Well, you only need to look back to the campaign. One of Biden's biggest rivals, of course, was Elizabeth Warren. and she really is the spokesperson for the movement, the pressure campaign, whatever you want to call it, to rein in the most controversial practices, and doing away with that loophole would be one way to do it. I agree that it's not a high priority, but that always seems to be at the top of every investor's list is what's going to happen now that a Democratic administration and a Democratic Congress is going to call the shots.
Adam: Right. Now, let's keep in mind that if they close the carried interest loophole, this isn't going to immediately balance the federal budget, which is of course in the trillions of dollars. The Congressional Budget Office has estimated that closing the loophole will return $14 billion to American taxpayers over 10 years, while some experts have suggested it could bring in more than 10 times as much to the Treasury. It's still a lot of money, but nowhere near what some of the other tax changes could potentially bring in.
Alexander: It's very symbolic.
Adam: Right, it's extremely symbolic.
Alexander: I think in a lot of ways, that drives it, and of course, the flip side, what you'd hear from the venture capitalists and the private equity firms is that it would do actually quite a bit of harm to the work they do, that it would have a chilling effect basically on the fundraising and the deployment of capital because it would be seen as a big burden that's just a disincentive to that line of work, basically.
Adam: Yes. I was reading the American Investment Council's website today about closing the carried interest loophole in their policy position, and just for background, the AIC is a private equity lobbying group in Washington, DC, and they are obviously against closing the loophole—and they would probably not even like us to call it a loophole—but their argument is that for the investors, by having the lower tax rate, it aligns your LPs, your investors with the portfolio companies.
If the company does well, the investor does well, and if the company does not do well, then the investor will not do quite as well, though private equity has shown an ability to still make money even when portfolio companies end up going bankrupt. But that is their stance that this tax policy that's been in place, I think, since 1913, that it's going to help push investors to help companies do good, basically to do well.
Alexander: You wrote about the legislation that Pascrell introduced, so that'll be one area to watch. It's not all about the Biden administration when it comes to something like this. He doesn't have to take any action other than look at what comes across his desk.
Adam: Just for some background here, Bill Pascrell is a congressman from New Jersey's 9th district, and if you're wondering why he would be interested in the carried interest loophole, as he calls it, Toys R Us—which had a very rocky history, to say the least, with private equity—was based in New Jersey before they sadly went bankrupt. He's another growing group of politicians that are trying to lay the clamp down on the private equity industry.
Let's pivot. I could go all day on taxes and private equity because that is, of course, my passion, but venture capitalists donated heavily to the Biden campaign, and there are some members within the administration who have close ties to the VC world. Do you think he's going to be a friendly president to the VC world, or at least the people he appoints?
Alexander: So far it kind of looks like that. There are some venture capitalists, of course, that are not Biden supporters, but by and large, you've got it right. The industry has been really close with this administration, with the Obama administration, and during the Trump era, this is an industry that got way more political than ever before, like, I guess, the whole of society, but especially so in the case of the tech industry and Silicon Valley. But there's a reason for that.
The contrast in administrations is huge when it comes to the political philosophy and the view of the innovation economy. The venture capital industry pretty uniformly considered Trump and the Trump administration one of the worst things that had happened for the world basically. These are people that tend to be very idealistic, they like to see their industry as being all about changing the world and that sort of thing.
You mentioned examples that I think you had in mind of who's in the administration. It's important to remember that his own Chief of Staff, Ron Klain, comes from a big VC firm in the Washington area, Revolution. You've got the doorkeeper to the Oval Office coming in there with VC's goggles on, not to paint him only as a venture capitalist, but that's obviously going to weigh heavily.
By the way, a couple of months, back I actually had a conversation with Steve Case of AOL fame, who's co-founder of Ron Klain's VC firm, Revolution. He was telling me about Klain and how he really does expect this administration to not so much do the bidding of the VC industry, but their agendas are very much aligned. They will be in cahoots on a number of things, especially regarding investing in research and development, innovation economy, and Steve Case's point was that like just having a president who uses the bully pulpit to attention to the value of entrepreneurship and innovation, that alone is a big difference. That's what you can expect from this administration. We'll talk some more about how that's happening right now with things like climate change, and their invocation of science and technology and having some kind of-
Adam: What a concept. Yes.
Alexander: In that sense, it is fair to assume that the industry is really happy with having this administration. They made no secret—"they" meaning venture capitalists—made no secret about their displeasure with Trump on immigration. That's a major priority, which we can get into right here. That's what to expect.
Specifically, at the close of the Obama term, the Obama administration passed a new rule that was designed basically to ease the ability of foreign founders, foreign-born entrepreneurs, to have a path to working and building companies in the United States. That rule got stopped dead in its tracks when the Trump administration came in and caused a lot of consternation in Silicon Valley, but really around the country. That's a top priority for the VC industry. I've spoken to the VC lobby, the National Venture Capital Association about this. They're quite passionate about reinstating that rule.
It's almost a certainty that it's going to happen. It's just a question of just a matter of time. As you said, at the top, there's so many more pressing priorities for an administration coming into office under a double crisis, that things like that are going to happen in pretty quick succession I think once the pandemic is under more control.
Adam: Do you think venture capital investors will be in favor of maybe the push towards regulating these Big Tech companies like Facebook, Amazon, Google? Is that something that could have a positive impact on the VC ecosystem? Because a lot of people have argued-
Alexander: It can. Yes, they're divided. They're divided about it. It's an interesting dilemma because there are frenemies basically out there. Frenemies with the big four—Amazon, Apple, Facebook, Google—in that they depend on them for a lot of ecosystems that they create. Of course, as we all know, most if not of all those big four can crush competition any number of ways, but they have so much power, they have such big feet, that they can stomp on anyone who comes in or acquire them. These big four, Big Tech companies, and also some of the newer Big Tech companies are themselves actively investing in startups.
It's a complex web of activity. There's no clear consensus within the tech industry really about how best to do that. I think that on the whole, it comes down on an expectation that there is going to be stronger and stronger anti-trust scrutiny, which actually started under the Trump administration.
Adam: It did. Yes.
Alexander: You have a fairly bipartisan move toward clamping down on Big Tech, not just through anti-trust avenues, but also just regulating other activity of theirs.
Adam: Did you just say bipartisan in this year 2021?
Alexander: I did.
Adam: Wow. It is interesting to me because, as a political science minor, who takes an interest in these sort of things, like you have the Republicans who are upset with Big Tech because they think they're good at being [...] their viewpoints are being censored or shadow banned. Then you also have a lot of Democrats mad at Big Tech companies for a totally different reason. Basically, they're anti-competitive practices, such as Facebook dominating the digital advertising market, or Facebook and Google, but they both are mad or have shown that they're willing to take action to maybe ... I don't know what the word is, not cut them down, but maybe put a cap on some of the things that they're doing to hurt other businesses.
Alexander: Well, I mean, some voices are definitely calling for breakups in a kind of AT&T style, way of resolving, having too much power in one company's control.
Adam: Lina Khan was recently named to the Federal Trade Commission, to a chair within that organization, which of course, oversees all this, and she is 32 years old, professor at an Ivy League school, who's been extremely, extremely critical of Big Tech, mainly their influence on the newspaper and the media industry, and kind of dominating that ad market, and she'll now have a vote, and she'll have some power. There are people who are coming into power now, who may have the ability to do something about it.
Alexander: Yes, we're definitely going to see a check on the power of Big Tech. It's popular in Washington. Thus, my careful but accurate choice of the word bipartisan, popular in Washington, it's popular in the heartland, increasingly, and even here in San Francisco, where I said, there's a level of disgust even among people that work in these industries.
Adam: With themselves, yes, in some ways.
Alexander: Some of it too is also about labor issues. You've seen, for instance, some landmark efforts to unionize places like Google and Amazon, that the unions have had mixed results there. Again, these are things that are [...] we're getting things that are largely outside the reach of Joe Biden, but again, he has the bully pulpit.
Adam: High approval ratings right now.
Alexander: Very high approval ratings. In fact with that, the other thing to keep in mind is that this is the time when you have that kind of political capital and high approval ratings, and you have a crisis on your hands that hasn't been seen in a century, the likes of which you haven't seen, you make bold moves. We're going to start to see that, and as we sit here recording this on April 21, tomorrow he's set to unveil some very ambitious targets for lowering carbon emissions by something like 50%, in a really short time, and that is a hot topic in the tech and the VC ecosystem.
Adam: Yes, you would certainly think that would open up a number of opportunities for venture capital, and private equity investors here over the next few years. I mean, private equity has [...] talked a lot in the last five, six years about ESG investing, where they try to provide an environmental, or social good, alongside returns to investors, and that can be in the type of companies that Biden's policies will place an emphasis on with climate change and a possible Green New Deal.
Alexander: I was going to say, there's also quite a large industry that's nascent, that's specifically geared to things like carbon capture, and clean energy, alternative to fossil fuel as what we're really talking about, biological companies that are specifically working in the energy field. Part of what Biden and Harris are talking about is actually directly funding some of these kinds of initiatives, which can go a long way toward de-risking what are generally considered some of the highest risk and most capital-intensive industries, in the VC ecosystem, at least.
Adam: How optimistic are you about public and private sort of investment type partnerships that, in general, yield anything?
Alexander: They don't have a very good track record.
Adam: They don't have a great track record, right?
Alexander: They don't, but it doesn't have to be that way. It doesn't have to be through partnerships. I like to think that, just to be a little optimistic about it for a sec, there are some things that have been learned, I think, from past efforts like that. I think that the federal government and state governments can play an active role in softening the ground. They're not necessarily formal partnerships as much as being on the same page and pulling the same oars in the same direction.
Adam: In the same direction. For sure.
Adam: Speaking of being on the same page, can we say it's infrastructure week? Is every weekend infrastructure week, or how do we classify this now?
Alexander: They say they want to build back better.
Adam: We want to build back better. That's right. Of course, Trump had an infrastructure week that never came to fruition in any sort of way, but the private equity industry has been preparing to help improve the United States infrastructure for a few years now by raising some really large funds, stretching into the billions, sometimes tens of billions of dollars in hopes of forming these public-private partnerships that we just touched on.
Private equity sees the next 10 years as an opportunity to put some of that money to work in building roads, bridges, other really essential infrastructure that, frankly, the United States has struggled to keep updated over the past 50 years or so. I think it's going to be a really exciting time if you're in that space in the private equity sphere.
Alexander: Didn't some of the private equity firms, like Blackstone, actually do some of their biggest fundraising recently around that theme in particular?
Adam: Yes, they did. Blackstone, I think it would be three years ago now, they made this huge announcement that we're going to raise $40 billion for an infrastructure fund, which would be their largest single pool of capital ever for one fund, and $20 billion of that money, of that anchor commitment, came from Saudi Arabia, from their public investment fund, which did raise some eyebrows at the time, given Saudi Arabia's track record with human rights and their potential involvement in murdering Jamal Khashoggi. That fund has not really gotten off the ground, to say the least.
That was the headliner for the whole industry. They're nowhere near close to that $40 billion goal. They subsequently announced that it's just going to be an open-ended vehicle. We're fundraising, we'll continue until, not really sure when, but they haven't made any huge investments out of it just yet. I'm sure Blackstone sees this as an opportunity to put their billions to work, hopefully, because they've committed a lot of time and money into this space, as have a lot of other really big asset managers other than Blackstone.
Alexander: You wrote recently about some of the comments that Jonathan Gray, I believe it was, that Blackstone made about how optimistic he was about Democratic control basically being a green light for a lot of the infrastructure opportunities that they had in mind in the first place. They seem pretty happy with where things are going.
Adam: They do. They do. Jonathan Gray, a big Democratic donor, ironically. He has expressed publicly a lot of optimism about the direction things could be headed. What would be the way to say this? He's excited about the opportunity.
Alexander: He's bullish.
Adam: He's bullish.
Alexander: He's bullish on $2 trillion in infrastructure spending, and who wouldn't be?
Adam: That, in their mind, and I've seen this sentiment repeated throughout the private equity industry is, yes, taxes are gonna be higher for us. A firm like Blackstone, their corporate tax rate, which they switched their status on. They switched officially to a corporation a few years ago. They expect that to go up, but their thought is that this push for infrastructure spending and other potential opportunities here over the next few years could offset those tax increases. Their stock price certainly hasn't suffered over the last six months since Biden was elected, so they're feeling good about things.
Alexander: You mentioned the stock market there, why don't we talk about SPACs for a second?
Adam: Yes. No conversation would be complete about the private markets without SPACs, which is counterintuitive, but-
Alexander: SPACs were the be-all-end-all for the first few months of this year. That, of course, is coming to a halt right now, or at least a pause, it remains to be seen. There's some real genuine signs of scrutiny of the SPAC market coming out of this administration. Gary Gensler, who is the incoming chairman of the Securities and Exchange Commission, is known to be a regulatory hawk of the financial industry. There are already signs that under his tutelage, the SEC is going to finally take the punchbowl away from the parties. What are the implications? What's at stake for the PE industry?
Adam: There's certainly a lot of money at stake for them, but it's not going to fundamentally—if Gensler does crack down on SPACs—it's not going to fundamentally destroy their business model or their ability to make money. As we've learned a lot before, private equity has played a role historically, creating these SPACs. They've pushed really hard back into the market here over the past year or so long with seemingly everybody else, including A-Rod and Jay Z and Snoop Dogg.
Alexander: They helped invent it.
Adam: They invented it. It didn't have a good reputation then. It was really interesting last year when this all was happening, there weren't really many people out there, there weren't that many critics out there saying like, "Well, let's take a step back here and see why is this possible exit avenue, why is it exploding in popularity? What are the risks for investors?" Going public via SPAC is very advantageous for the investor that's doing it.
You cut down a lot of your costs through the IPO process, and there isn't as much scrutiny. There's been rumors that one of Gensler's first—I wrote about this a little bit in The Weekend Pitch recently, shameless plug—that he's going to change the way you're going to have to account for the way you list your shares. Warrants were a big part of why SPACs were so attractive initially to investors because it allows basically the average retail investor. This is getting way inside [...], but they can really lever up and make a lot of money off these warrants. If Gensler cracks down on warrants, then that could make it, I guess, less appealing for the private equity firm to take the company public that way.
Alexander: It removes a lot of the incentive. It's a sweetener-
Adam: It removes incentives for a hedge funder Joe Schmo to get in and buy up all the penny stocks. I think it could definitely have a cooling effect like it will on other investors, which personally I don't think would be a bad thing to just step back for a moment, say, let's make sure that the investors who are involved with these companies are aligned with the shareholders. The average investor, like say a 30-year-old private equity rider who dabbles in stocks, wouldn't be worked over by forces unforeseen or anyone else. I think Gensler will have an impact for sure.
Alexander: No doubt. All right, Adam. Well, we covered a lot of what to expect from this new administration. Keep in mind it's only a few months in, and with the double crisis going on, we can expect that over this year, and next year, a lot of this will actually materialize, but it's an issue. All these policy areas, we're going to be watching them very closely and looking forward to seeing what happens.