A Deep Dive Into Private Equity - Part 1

On this episode of Drilling It Down, Wes and Mario dissect the intricate world of private equity, particularly its repercussions for the dental sector. The discussion is initiated by the thought-provoking article "Slash and Burn: Is Private Equity Out of Control?" which serves as a catalyst for examining the dual nature of private equity investments. Mario reveals that these investments may not yield superior returns compared to traditional options such as low-cost index funds, challenging the narrative of private equity as a surefire wealth generator. The hosts further clarify how private equity firms typically utilize considerable debt to acquire businesses, often placing financial strain on the companies involved. They cite examples of major brands like Toys R Us and Sears, which collapsed under the weight of leveraged buyouts. Emphasizing transparency, Wes highlights the often concealed fees that diminish true investor returns, raising questions about the overall benefit of private equity in various industries. Wes and Mario address the controversial carried interest loophole that allows private equity insiders to pay lower taxes than ordinary earners, contributing to economic disparity.

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Listen to our sister show, Next Gen DDS! An all-in-one resource for dental students, residents, and early career doctors, discussing both clinical and business aspects of dentistry, hosted by Wes Lyon and Dr. Scott Menaker.

Episode Transcript

Wesley Lyon: Welcome back to another episode of Drilling It Down. This is your host, (00:02):
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Wesley Lyon: Wes Lyon, co-hosting today. I have Mario Santiago. Mario, welcome back. (00:06):
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Mario Santiago: Thanks, Wes. Happy to be here. (00:10):
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Wesley Lyon: Oh, absolutely. So, Mario, I sent you an article we're going to discuss today. (00:12):
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Wesley Lyon: So, kind of, if you don't mind, introduce the article and topic. (00:16):
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Wesley Lyon: What are we talking about? (00:18):
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Mario Santiago: Yeah, pretty interesting stuff. So, the article is called Slash and Burn. (00:19):
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Mario Santiago: Is private equity out of control? (00:23):
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Mario Santiago: Super interesting read, and we just thought it'd be a good idea to take a deeper (00:26):
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Mario Santiago: dive into it today and specifically private equity and as it relates to dentists, (00:29):
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Mario Santiago: but really just what private equity is as a whole. (00:34):
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Wesley Lyon: No, definitely. And it's something we talked about in kind of last month's McGill (00:37):
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Wesley Lyon: and Lyon Dental Advisory, three things to avoid, and one of which was private equity. (00:43):
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Wesley Lyon: So I thought this article was kind of timely. I think it came out right after (00:48):
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Wesley Lyon: I actually wrote our article, which we touched on it briefly, (00:53):
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Wesley Lyon: but today's podcast, we want to touch on it a little bit more detail. (00:56):
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Wesley Lyon: So what'd you find interesting in this thing? (01:00):
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Mario Santiago: Yeah, it's just super interesting because when we talk to a lot of dentists, (01:04):
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Mario Santiago: they just hear the word DSO, right? (01:07):
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Mario Santiago: But there's also private equity and there's DSOs that are backed by private equity. (01:09):
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Mario Santiago: And I think it's very useful to read an article like this and just take a step (01:14):
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Mario Santiago: back and understand where the money is actually coming from and where the decisions (01:19):
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Mario Santiago: are actually being made and then taking a deeper dive into how it affects the DSOs. (01:22):
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Mario Santiago: But it's just super interesting. The article basically takes a deep dive and (01:27):
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Mario Santiago: refutes the notion that private equity is really good for money, (01:31):
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Mario Santiago: for people, for society. (01:36):
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Mario Santiago: And it really talks about how one of the most interesting things I found is (01:37):
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Mario Santiago: that the return in private equity investments maybe isn't as good as you just (01:41):
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Mario Santiago: going out and investing in a low-cost index fund. (01:45):
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Mario Santiago: I think that was the biggest thing that I found. (01:48):
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Mario Santiago: But I'll ask you some questions, Wes, too, down the road, and I found this to be super interesting. (01:51):
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Wesley Lyon: Definitely. And for those of you listening, part one, we're going to concentrate (01:56):
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Wesley Lyon: on private equity as an investment. (02:00):
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Wesley Lyon: Now, some of this stuff is going to relate, but we're going to also record part (02:02):
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Wesley Lyon: two today, which will be out about a week after part one. (02:05):
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Wesley Lyon: And in part two, we're going to really talk a little bit more in depth about (02:09):
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Wesley Lyon: how this impacts DSOs and selling to a DSO. (02:12):
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Wesley Lyon: But for today, yeah, Yeah, we just want to dive in, you know, (02:17):
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Wesley Lyon: if you're looking whether or not it's, you know, a dental private equity group (02:20):
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Wesley Lyon: or some private equity group that comes to you invest, you know, (02:23):
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Wesley Lyon: want to figure out how does this stuff really work? Whether the return stream's really there? (02:26):
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Wesley Lyon: My advisor approached me with something like this. Should I really do it? (02:30):
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Mario Santiago: Yeah. Well, I wanted to start off with, it might sound like a basic question, Wes, but- (02:34):
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Mario Santiago: Can people out there listening to this today, can they invest in private equity? (02:39):
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Mario Santiago: And if so, how does it usually happen? Like you said, do you get approached (02:43):
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Mario Santiago: by someone? Do you approach someone about it? (02:46):
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Mario Santiago: Is it something that's only available (02:49):
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Mario Santiago: to, you know, the wealthy and the rich? And is it a status thing? (02:51):
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Wesley Lyon: Yeah, for those of you listening who don't know us as well, maybe first-time (02:55):
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Wesley Lyon: listeners, John McGill actually plucked me out of an institutional money manager. (02:59):
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Wesley Lyon: So that might be a good starting point of private equity firms are more of what (03:04):
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Wesley Lyon: I'd consider the institutional money managers. (03:09):
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Wesley Lyon: They don't really sell to retail as much. (03:11):
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Wesley Lyon: And where this comes in is most of you are going to get approached by a financial (03:16):
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Wesley Lyon: advisor or somebody, and that's how you would get into it. (03:19):
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Wesley Lyon: Some others, you may be able to get into it. (03:22):
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Wesley Lyon: Somebody may approach you, especially if you got $25, $30 million, (03:25):
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Wesley Lyon: you might $100 million, they might approach you directly. Most people, (03:30):
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Wesley Lyon: though, they're not going to have access to this world outside of a financial advisor. (03:34):
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Wesley Lyon: But then this is where it kind of gets funny on, you know, a lot of advisors (03:39):
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Wesley Lyon: sell this as access and they have ability into stuff. And I just crack up with access. (03:44):
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Wesley Lyon: I left my cell phone on the counter right here because I've got a couple of (03:49):
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Wesley Lyon: CEOs' phone numbers in there. (03:54):
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Wesley Lyon: I've sat down, had lunch with these people. I know them. I've got one of them (03:56):
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Wesley Lyon: that calls me and is always, hey, we'd love to talk about this investment philosophy. (04:01):
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Wesley Lyon: So as far as access goes, it's not something that's wildly difficult to get (04:07):
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Wesley Lyon: access to as a financial advisor. (04:13):
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Wesley Lyon: It's actually very easy if you have a lot of money to go ahead and get access to this stuff. (04:15):
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Wesley Lyon: I think a lot of advisors try to sell access and sophistication, (04:21):
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Wesley Lyon: and that's really how you get the access, though, or why it comes about. And, (04:25):
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Wesley Lyon: Whether or not you should do it is a whole different ballgame. (04:30):
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Mario Santiago: But there's probably a lot of incentive if somebody tells you, (04:34):
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Mario Santiago: hey, I got access to this thing that only you can invest in. (04:38):
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Mario Santiago: And I'm guessing a lot of people find that very attractive. (04:41):
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Wesley Lyon: It's sold that way. I don't know as many people. (04:44):
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Wesley Lyon: I don't know how attractive it is. I remember we were – I got flown up to New (04:48):
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Wesley Lyon: York City with about 10 other partners at an extremely large RIA. (04:52):
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Wesley Lyon: We may have been, and RIA is a registered investment advisory firm. (04:57):
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Wesley Lyon: At the time, we may have been one of the largest. (05:00):
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Wesley Lyon: I used to work for one of the largest aggregators. So I get flown up there and, (05:04):
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Wesley Lyon: you know, there's, call it 10, 15 of these private equity firms. (05:08):
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Wesley Lyon: And, you know, it's all the senior partners in me. (05:13):
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Wesley Lyon: And the senior partner I worked for thought it was funny to send me because I was a numbers guy. (05:16):
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Wesley Lyon: You know, you're not going to skate something by me. I'm going to read every (05:22):
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Wesley Lyon: last detail of what we're getting into. (05:25):
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Wesley Lyon: So I would always ask questions and kind of the a-hole in the room to some extent (05:28):
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Wesley Lyon: of, oh, this isn't going to work. (05:33):
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Wesley Lyon: So I was up there and, you know, I kind of kept my mouth shut to some extent (05:35):
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Wesley Lyon: because most of it just didn't make sense. And I felt grime. (05:39):
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Wesley Lyon: You just didn't get a good feeling from it. I remember there were specifically (05:43):
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Wesley Lyon: there were these two guys who are there. I mean, they were young, (05:47):
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Wesley Lyon: like 28 and 26, and they were coming to sell their private equity fund. (05:52):
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Wesley Lyon: And it was, you know, the premise of it was there were all these. (05:57):
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Wesley Lyon: You know, in 2008, the financial crisis was created by a lot of mortgage-backed (06:02):
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Wesley Lyon: securities, a lot of issues that went on there, credit default swaps, (06:06):
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Wesley Lyon: other very, very complicated products. (06:09):
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Wesley Lyon: And then there were these things that were basically synthetic mortgage-backed securities. (06:12):
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Wesley Lyon: And by synthetic, we mean, hey, we don't actually own this or insure against it. (06:19):
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Wesley Lyon: However, we're going to pretend as if we do. So it was a makeshift security. (06:25):
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Wesley Lyon: And their whole premise was, hey, we can buy these and we know what's in them (06:29):
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Wesley Lyon: and we can make money off of them. (06:33):
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Wesley Lyon: So the natural question came up, well, what makes you two better at this than everybody else? (06:35):
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Wesley Lyon: And the answer was, we built them. (06:41):
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Wesley Lyon: And I was like, let me just get this straight. You two knuckleheads were probably (06:44):
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Wesley Lyon: 22 and 24. You were at some desk. (06:48):
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Wesley Lyon: You were creating these products. They helped blow up the economy. (06:51):
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Wesley Lyon: And now your sales pitch for your private equity fund is only we really know what's in them. (06:55):
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Wesley Lyon: And I just sit there. I'm like, I cannot sit there in front of a client and (07:00):
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Wesley Lyon: tell them this is a good idea. This is the grimiest thing I've ever heard. (07:05):
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Wesley Lyon: So the CEO or the CIO, chief investment officer of the whole firm, (07:08):
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Wesley Lyon: comes and sits next to me at lunch that day. (07:13):
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Wesley Lyon: He's like, Wes, what'd you think? I was like, Rob. (07:16):
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Mario Santiago: This is grimy. (07:19):
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Wesley Lyon: Like, what are we doing? And I was always known, still am. I've always been my blunt self. (07:22):
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Wesley Lyon: So I just asked it and I was pleasantly surprised at the answer Rob gave me. (07:27):
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Wesley Lyon: It was, I want to put a dollar with these guys. (07:32):
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Wesley Lyon: However, our competitors are selling access to something and we need to be able (07:35):
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Wesley Lyon: to say we also do this, but I want to put client money there. And I'm just laughing. (07:41):
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Wesley Lyon: I'm like, so the whole thing is we need to be competitive. And he's like, you got it. (07:46):
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Wesley Lyon: So we've got this platform of availability, but even our chief investment officer, (07:50):
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Wesley Lyon: you know, it's like, it's just there because of how other advisors sell. (07:54):
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Wesley Lyon: But this access stuff, I just always laugh. (07:58):
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Mario Santiago: But the article dives into that too, about how it just bleeds into every industry, (08:02):
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Mario Santiago: every company, almost to the point where it's hard to back out. (08:08):
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Wesley Lyon: Yeah, that kind of gets into the, I think the access thing, just to kind of (08:12):
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Wesley Lyon: wrap that up and move on. The access thing is a joke. (08:17):
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Wesley Lyon: I always laugh. Last time we were speaking, I just pulled up my cell phone. (08:20):
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Wesley Lyon: I'm like, look, these guys can get the sales guy on the phone. (08:24):
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Wesley Lyon: I can get the dang CEO on the phone. (08:27):
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Mario Santiago: But I'm still not putting your money there. (08:28):
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Wesley Lyon: You just won't catch me doing it, which I think maybe to get into that point, (08:31):
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Wesley Lyon: I think we need to talk a little bit more about what it is. (08:36):
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Wesley Lyon: Now, there was something in there for those of you listening. (08:39):
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Wesley Lyon: I did not get on the same page with Mario. I told him to read the article so (08:42):
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Wesley Lyon: I can quiz each other here on what you found interesting. (08:46):
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Wesley Lyon: There was something very interesting I found in there, and it had to do with (08:50):
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Wesley Lyon: the debt. Did you find that one? (08:54):
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Mario Santiago: Basically how they use debt to finance all these operations. (08:56):
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Mario Santiago: Yeah, I think, correct me if I'm wrong, but basically they use all this debt, (09:00):
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Mario Santiago: but they put the debt, They don't actually have to assume the debt. (09:04):
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Mario Santiago: The PE groups, they have the company that they buy assume the debt. (09:08):
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Mario Santiago: And then some of these companies will go bankrupt and all this stuff. (09:11):
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Mario Santiago: And then when they close the doors, the original PE investors still get paid (09:14):
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Mario Santiago: out probably more than they put in and they leave the firm in a worse spot. (09:19):
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Mario Santiago: I don't know if I explained that well, Wes. (09:23):
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Wesley Lyon: That was a very simple explanation of what goes on a lot of times. (09:25):
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Wesley Lyon: And I think some of the famous examples in here were Sears. A lot of people wonder. (09:29):
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Mario Santiago: Toys R Us. (09:35):
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Wesley Lyon: Oh, I'll get into the Toys R Us model. because I actually, I have an article (09:36):
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Wesley Lyon: inbound about what happened there. (09:41):
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Wesley Lyon: It's a little related to actually a dental DSL. I'm not going to name it, (09:43):
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Wesley Lyon: but yeah, I think the important part of this, okay, they're going in, (09:46):
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Wesley Lyon: levering up these companies, stripping them down. (09:51):
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Wesley Lyon: Okay, what is private equity actually doing? (09:53):
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Wesley Lyon: And what they're really doing is trying to manage assets because they typically (09:56):
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Wesley Lyon: charge 2% of assets under management and 20% of profits, which is a pretty hefty fee. (10:01):
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Wesley Lyon: So they're extracting a lot of money from these PE groups or from the companies. (10:08):
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Wesley Lyon: But what they actually do is they go in and, gosh, we're going to have to look here. (10:14):
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Wesley Lyon: What was the number on how much of the money comes from investors versus debt? (10:19):
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Mario Santiago: It was a very small amount. Let me see. (10:24):
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Wesley Lyon: It was basically, we'll see if we can find it here. (10:27):
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Wesley Lyon: But on average, it's a very minimal amount of capital that gets in there that's (10:30):
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Wesley Lyon: not borrowed. They're basically levering up and using the profits of the company (10:35):
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Wesley Lyon: to pay back the ownership of it. (10:41):
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Wesley Lyon: So they're not really invested with their own money at the same side of the (10:44):
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Wesley Lyon: table as the sellers are. (10:48):
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Mario Santiago: Yeah, I can't find the specific number, but... (10:52):
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Wesley Lyon: But yeah, it's pretty hefty. We'll see if we can get it. (10:56):
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Wesley Lyon: But it's over like three quarters of the money to buy a company comes from debt. (10:59):
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Wesley Lyon: I want to say it was even like seven out of every $8 used or something, (11:04):
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Wesley Lyon: but don't quote us on that one. (11:08):
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Mario Santiago: But if I'm hearing you correctly, a PE firm comes in to, let's just use a company (11:10):
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Mario Santiago: like Toys R Us or whatever. (11:16):
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Mario Santiago: They come in, they assume a ton of debt, but they have the company assume all the debt. (11:18):
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Mario Santiago: They get paid out a management fee of 2%, and then they get the profits of like (11:23):
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Mario Santiago: 20%. Then the company maybe goes down the hole and they back out, (11:28):
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Mario Santiago: and they're not responsible for paying that debt, and they got their payout. (11:33):
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Wesley Lyon: Exactly. They can leave the company in really, really bad shape and still make money. (11:36):
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Wesley Lyon: And a lot of people don't realize that, you know, the private equity money on (11:42):
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Wesley Lyon: it a lot of times is sitting in their two and 20. (11:47):
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Wesley Lyon: It's not sitting on the return of capital to the actual people that put it into (11:51):
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Wesley Lyon: the private equity fund. So they'll strip down companies, take everything out (11:55):
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Wesley Lyon: for themselves, and maybe the investors get a paycheck. Maybe they don't. (11:59):
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Wesley Lyon: And they advertise these great returns. And don't get me wrong. (12:05):
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Wesley Lyon: They have great returns. It's just for who? (12:08):
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Wesley Lyon: Like, is it really for you? And the answer of that is probably not. (12:11):
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Mario Santiago: Yeah. And I think it's interesting, too, because the returns are clearly going (12:17):
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Mario Santiago: to the people who already have a ton of money. (12:21):
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Mario Santiago: But it sounds like also they have all these tips and tricks where they, (12:23):
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Mario Santiago: I think I read that a lot of the money that they get, they can characterize (12:27):
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Mario Santiago: as capital gains versus just profits and they get to pay less tax on it. (12:31):
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Mario Santiago: So they just keep on getting richer and richer off this kind of stuff. (12:35):
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Wesley Lyon: Yeah, this is a political hotspot. So let me come back to that. (12:38):
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Wesley Lyon: I'm going to wrap this one up, but their basic model is to go buy a. (12:42):
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Wesley Lyon: Companies with tons and tons of debt that they get from the banks. (12:47):
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Wesley Lyon: So they get the money lent to them. They straddle the companies with debt, (12:51):
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Wesley Lyon: something we call a leveraged buyout. (12:55):
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Wesley Lyon: So if you're wondering what a leveraged buyout is in financial terms, (12:57):
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Wesley Lyon: it's just assuming a ton of debt to buy a company. (13:01):
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Wesley Lyon: Like I always, somebody asked me if we were private equity back. (13:05):
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Wesley Lyon: They didn't know what's going on with me and John. (13:08):
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Wesley Lyon: I was like, well, if by private equity, you mean I took the loans and I'm private, then yes. (13:09):
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Mario Santiago: But that's it. (13:14):
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Wesley Lyon: We don't have anybody else in the walls here that's got their butt on the line or somebody. (13:15):
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Wesley Lyon: It's just me with my butt on the line for what goes on. But are we private? (13:21):
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Wesley Lyon: No, but that's all they're doing is they're taking the debt that somebody like (13:26):
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Wesley Lyon: me would have had to have taken. (13:29):
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Wesley Lyon: They're assuming it. They're coming in and running it. Their idea is they can (13:31):
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Wesley Lyon: run it better, they can make it more profitable, and they can leave it in better (13:35):
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Wesley Lyon: shape, which kind of leads into the next thing I think you're alluding to is (13:39):
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Wesley Lyon: do they actually do that? (13:43):
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Mario Santiago: Yeah. And so if somebody approaches you about this, is it a worthy investment? (13:45):
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Wesley Lyon: In my opinion, no, it's not. So a couple issues here if you could approach with this. (13:50):
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Wesley Lyon: First is people need to understand how things get valued. If I buy a mutual (13:57):
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Wesley Lyon: fund of publicly traded stocks, they own these stocks. (14:02):
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Wesley Lyon: And I used to work for a very large mutual fund company, like sixth largest in the country. (14:06):
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Wesley Lyon: So when we value what your shares are worth, it's very simple. (14:11):
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Wesley Lyon: A mutual fund is a partnership and you own whatever tiny percentage of it. (14:15):
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Wesley Lyon: If the mutual fund's assets that are publicly traded, easy to value, (14:19):
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Wesley Lyon: and this would go for an index fund, right? (14:25):
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Wesley Lyon: If I bought a Vanguard index fund, my share of that index fund is whatever percentage (14:27):
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Wesley Lyon: of the fund that I own, which is going to be very tiny. (14:34):
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Wesley Lyon: I mean, these index funds are huge, but okay, at close of market, (14:37):
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Wesley Lyon: the shares were worth whatever, $1.2 billion, and my little piece of it is worth (14:41):
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Wesley Lyon: $66,000. I have $66,000 in that mutual fund. (14:48):
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Wesley Lyon: That's it. It's plain and simple. You go to sell that mutual fund, (14:52):
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Wesley Lyon: you can get $66,000, and you can do it pretty much any day you want the market is open. (14:55):
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Wesley Lyon: When you're in a private equity investment, they're valuing what they think the assets are worth. (15:01):
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Wesley Lyon: Now, they're charging a 2% assets under management fee. (15:08):
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Wesley Lyon: You think they want to value the assets lower or higher? (15:11):
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Mario Santiago: They're probably going to paint that rosier picture. (15:15):
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Wesley Lyon: They do. And this is where it's really hard to track the returns. (15:17):
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Wesley Lyon: There are a lot of benchmarks in there talk about private equity returns. (15:21):
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Wesley Lyon: But a lot of those returns are recorded on the books. they're not actually realized (15:25):
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Wesley Lyon: so a lot of people don't understand you know okay, (15:31):
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Wesley Lyon: So I'm showing a 14% return, but it's money on a piece of paper that you may or may not see. (15:35):
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Wesley Lyon: The other thing they do is, you know, it's hard to get in there. (15:41):
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Wesley Lyon: There's not like clear, solid reporting standards of, oh, the fund made 14%. (15:46):
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Wesley Lyon: Was that before or after management fees? (15:51):
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Wesley Lyon: We actually had a client come in and he had gotten scrolled into a couple private equity investments. (15:53):
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Wesley Lyon: And I was thinking we were about to have an ugly conversation. (15:58):
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Wesley Lyon: I said, hey, did you know about this? And he starts laughing, (16:01):
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Wesley Lyon: goes, it wasn't a ton of money, but I've learned my lesson. (16:04):
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Wesley Lyon: And we're looking at it, you know, it's got a stated return rate that's pretty high. (16:08):
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Wesley Lyon: However, that was pre-fees. So you look and the fund had $6 million of assets in it to start. (16:13):
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Wesley Lyon: The assets, I think, in the return had grown to be like $8.5 million. (16:21):
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Wesley Lyon: But the fees and management expenses that the private equity fund had charged (16:26):
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Wesley Lyon: over the time period was $2.5 million. So you actually looked, (16:30):
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Wesley Lyon: and the amount of money in the fund from the beginning to the end was the same, (16:33):
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Wesley Lyon: and yet they were claiming a positive return. (16:37):
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Wesley Lyon: And some people buy this stuff, and they see it on paper, and they don't know any better. (16:40):
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Wesley Lyon: Truthfully, I think a lot of advisors out there also get duped into this. (16:45):
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Wesley Lyon: They don't work. They've never had the institutional money management experience (16:50):
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Wesley Lyon: of going in there and actually figuring this stuff out, what the return was. (16:54):
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Wesley Lyon: And because of that, they see the returns and they kind of buy them without (16:59):
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Wesley Lyon: asking deep questions on, you know, like a lot of fun, a lot of these private (17:02):
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Wesley Lyon: equity companies, you know, they'll show you, oh, here's our track record. (17:08):
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Wesley Lyon: Well, you got to ask more questions. (17:10):
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Wesley Lyon: Those are the ones that worked. What's the track record? how many funds did (17:12):
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Wesley Lyon: you shut down that you're not telling me about? (17:15):
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Wesley Lyon: And all these questions really tell not so great stories for most private equity funds. (17:18):
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Wesley Lyon: So the problem isn't necessarily that they can't make money. (17:24):
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Wesley Lyon: They can make lots of money. The problem is who they're making it for. (17:27):
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Wesley Lyon: And it's very seldom that they're really looking out for the end investors in sight. (17:30):
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Wesley Lyon: I mean, it's insane how much they get paid at these private equity firms. (17:35):
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Mario Santiago: Yeah. And the other thing that was interesting, now that you mentioned about (17:39):
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Mario Santiago: tracking their performance, you know, the article really said that only about (17:41):
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Mario Santiago: 60, I think, percent or maybe half of all the private equity firms are actually (17:45):
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Mario Santiago: tracked in terms of benchmarks. (17:51):
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Mario Santiago: So we don't actually know what the other 40% or so is doing. (17:53):
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Mario Santiago: And it's probably more likely that that other 40% is not doing so hot. (17:57):
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Mario Santiago: So they're really only tracking maybe the best performers to show an overinflated return. (18:01):
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Wesley Lyon: Yeah. And you're looking at the benchmarks there, right? There's not good benchmarks on this. (18:06):
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Wesley Lyon: That's where in public equity markets or publicly traded stocks, (18:10):
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Wesley Lyon: we have good benchmarks. (18:14):
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Wesley Lyon: There's oversight, management, all this stuff goes on. (18:15):
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Wesley Lyon: It's very rare a publicly traded company goes under because of this. (18:19):
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Wesley Lyon: So, whole different ballgame there. But yeah, that's exactly right. (18:25):
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Wesley Lyon: And I did get a good laugh in this article. (18:29):
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Wesley Lyon: I know this because working in an institutional money manager, (18:32):
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Wesley Lyon: we saw a lot of pension funds, a lot of things going on. (18:35):
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Wesley Lyon: And they mentioned how the pension funds, they get higher returns, they all invest in it. (18:38):
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Wesley Lyon: The truth is, and they even, I won't call out ones I know about in there, (18:44):
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Wesley Lyon: but whether or not a pension fund is over underfunded is public knowledge. (18:48):
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Wesley Lyon: You can go look this up. And they're going through, and they mentioned a lot (18:53):
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Wesley Lyon: of the ones investing in private equity that I know to be underfunded because (18:57):
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Wesley Lyon: of poor return histories of the managers. (19:02):
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Wesley Lyon: So they're sitting there and, you know, you might say, oh, this thing has an (19:05):
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Wesley Lyon: 11% return on paper, but then you look at the pension fund and it is grossly (19:09):
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Wesley Lyon: underfunded and poor investment results have a lot to do with that. (19:14):
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Wesley Lyon: They don't want to admit to it, but it has a ton to do to it because we used to... (19:19):
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Wesley Lyon: They all, you know, there's all these standards on how to evaluate investment (19:23):
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Wesley Lyon: performance, and most of them are pretty screwy, if we're being honest. (19:27):
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Wesley Lyon: So they sit there and you look at it and you're going, well, (19:32):
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Wesley Lyon: how are you underfunded? (19:35):
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Wesley Lyon: And then look at us, what's your five-year track record? And we're like, (19:36):
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Wesley Lyon: well, this is our five-year track record and here's why. (19:39):
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Wesley Lyon: And in the stock market, there's characteristics, things we were doing to position (19:41):
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Wesley Lyon: portfolios away from an index. (19:47):
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Wesley Lyon: And it doesn't always work. We know statistically it'll work over a 40-year (19:49):
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Wesley Lyon: period, but over a five-year period in the investment world, we call that noise. (19:53):
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Wesley Lyon: But that was all they cared about. And these private equity firms would come (19:57):
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Wesley Lyon: in to show them a five-year track record, and they'd not show them all the other (20:01):
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Wesley Lyon: stuff, and they'd invest. (20:04):
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Wesley Lyon: And there's a lot of pensions in America that are just wildly underfunded. (20:06):
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Mario Santiago: Oh, my gosh. And a lot of people relying on that, right? (20:11):
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Wesley Lyon: No, absolutely. Which I think this might be a good, this will be an example, (20:14):
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Wesley Lyon: a really, really good example of a private equity firm ruining a company but making profits. (20:21):
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Wesley Lyon: So you mentioned Toys R Us. I don't know, how familiar are you with the Toys R Us debacle? (20:25):
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Mario Santiago: Not as much as you. I'm about to find out. (20:30):
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Wesley Lyon: So Toys R Us got bought by a private equity company. I don't know exactly when. (20:33):
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Wesley Lyon: Kind of got run into the ground. (20:38):
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Wesley Lyon: But I believe, and again, don't quote me on exactly on this. (20:40):
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Wesley Lyon: It's been a little while since I really followed this stuff closely. (20:44):
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Wesley Lyon: I don't work in that industry as much anymore. (20:47):
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Wesley Lyon: Um so what they did (20:49):
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Wesley Lyon: though was they sold the real estate (20:52):
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Wesley Lyon: and leased it back at ridiculous rates and (20:56):
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Wesley Lyon: when they sold the real estate the money the profit became in the real estate (21:00):
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Wesley Lyon: but they straddled the company with all these you know ridiculous rent rent (21:04):
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Wesley Lyon: payments yeah but when they showed that profit on paper for selling it they (21:11):
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Wesley Lyon: were able to take a huge chunk out so torys russ ended up defunct, (21:15):
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Wesley Lyon: but the private equity companies ended up good. (21:19):
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Wesley Lyon: I mean, it's just not something. And I don't know that the investors ended up (21:23):
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Wesley Lyon: good. I do know that the private equity firm ended up fine. (21:27):
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Wesley Lyon: And, you know, there's also, I didn't get into this, so don't use Toys R Us as a perfect example. (21:30):
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Wesley Lyon: But for the sake of not being sued by somebody who doesn't like what I have (21:36):
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Wesley Lyon: to say with a lot more money than we do, I'm not going to give specific examples, (21:40):
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Wesley Lyon: but I have them in my head, (21:44):
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Wesley Lyon: where a lot of these sale leaseback arrangements, there's a huge conflict of (21:45):
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Wesley Lyon: interest and the company doing it is maybe benefiting on the other side of it. (21:49):
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Wesley Lyon: So they're making their money on the purchase of the real estate. (21:54):
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Wesley Lyon: Because I know a very, there's a very prominent politician. (21:57):
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Wesley Lyon: Involved in this. And there's a lot of politicians involved in this, (22:02):
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Wesley Lyon: which will come into our last thing we want to talk about, which is taxation and why it exists. (22:06):
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Wesley Lyon: But there's a very prominent politician who is thought of to made his money (22:10):
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Wesley Lyon: being a genius in private equity. (22:15):
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Wesley Lyon: What actually went on was when they were putting the European Union together, (22:17):
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Wesley Lyon: every member country had to have a balance sheet or, you know, (22:21):
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Wesley Lyon: had to have, he couldn't be running a certain amount of deficits. (22:26):
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Wesley Lyon: I don't know exactly the details, but what they did was they engineered a sale (22:29):
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Wesley Lyon: leaseback of all of the country's like major assets. (22:33):
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Wesley Lyon: So they really made their money. And what I would think from a bystander, (22:39):
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Wesley Lyon: you look at it and you go, that's corrupt. (22:44):
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Mario Santiago: Like there's nothing. (22:46):
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Wesley Lyon: You sold off all of the very expensive buildings, monuments of this European country to lease back. (22:47):
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Wesley Lyon: And when they do this, you know, there's not the same accounting standards applied to this. (22:54):
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Wesley Lyon: You know, they're applying governmental accounting standards. (22:59):
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Wesley Lyon: So they're showing the sales is revenue, even though it's not recurring. (23:02):
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Wesley Lyon: So that's an odd one is CPAs. You might not have realized the why behind that. (23:06):
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Wesley Lyon: But when you took the CPA exam, we don't deal with government accounting, (23:10):
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Wesley Lyon: but you knew there were two sets of rules. (23:13):
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Wesley Lyon: And it's just absurd that they're making money off of stuff like this. (23:15):
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Wesley Lyon: Again, I don't know what the investors did, right? (23:20):
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Wesley Lyon: He's not a commoner investment person. This person is a partner in the firm, (23:24):
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Wesley Lyon: and that's who's really extracting all the money out is private equity is investment. (23:31):
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Wesley Lyon: If you're a partner at a firm, you're going to make a killing, absolute killing. (23:36):
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Wesley Lyon: But if you're just nobody investing in it, they're not out for you in it. (23:41):
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Wesley Lyon: So we really want to stay as far away as possible in it. (23:49):
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Mario Santiago: So my big question, Wes, is private equity good for all these industries? (23:53):
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Mario Santiago: And I guess specifically dentistry? (23:59):
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Wesley Lyon: I'm going to put that question back to you. And I love this one. (24:01):
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Wesley Lyon: And I think it was actually a practice broker that sent this out in an email. (24:06):
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Wesley Lyon: And I'm usually not this blunt about it because we'll talk about relates to dental practices. (24:10):
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Wesley Lyon: We're not necessarily against selling to a private equity firm. (24:14):
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Wesley Lyon: We just need to understand what we're getting into. But can you name one industry (24:17):
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Wesley Lyon: that's been gobbled up by private equity that you think runs better? (24:20):
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Mario Santiago: Yeah, no, I can't, especially after reading a bunch of this stuff. (24:24):
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Mario Santiago: I just, I'm not convinced that the actual industry itself is better, (24:28):
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Mario Santiago: but people got rich off it. (24:34):
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Mario Santiago: But I don't know if it was the people who actually worked in that industry. (24:36):
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Mario Santiago: It's people that maybe had nothing to do with that industry. (24:39):
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Wesley Lyon: No, definitely, which I think gets into why people sell to them. (24:42):
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Wesley Lyon: But if you think of like HVAC companies, plumbing companies, my gosh, I mean- (24:46):
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Wesley Lyon: I don't know if you rent, you don't have to deal with this, but I always go (24:52):
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Wesley Lyon: out of my way to try to find the local guy. And a lot of people do, (24:55):
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Wesley Lyon: like, I just want the local guy. (24:58):
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Wesley Lyon: And usually they're swarmed with work. So it takes a little bit more time, (25:00):
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Wesley Lyon: but they don't absolutely rip you off. (25:02):
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Wesley Lyon: Like I, I had to get my driveway dug up. The sewage was going the wrong direction. (25:05):
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Wesley Lyon: And I was leaving and I had two guys living in my house that my wife was super (25:12):
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Wesley Lyon: enthused about with COVID. (25:17):
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Wesley Lyon: They were supposed to buy a house and then COVID hit and they didn't buy one. (25:19):
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Wesley Lyon: So, they were stuck living with me, but I'm leaving. (25:23):
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Wesley Lyon: The sewage is going the wrong way. So, I call the person and get there in an hour. (25:26):
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Wesley Lyon: I paid a lot of money, like more than my wife's engagement ring and had the next guy come about. (25:30):
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Wesley Lyon: And I asked somebody, I said, can you look at this, do whatever. (25:37):
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Wesley Lyon: And he's like, you overpaid and I'm not going to really get into the details. (25:40):
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Wesley Lyon: So I had my whole driveway dug up, all the pipes replaced. So then I'm at a (25:44):
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Wesley Lyon: wedding like three weeks later, and I'm talking to a buddy I haven't seen in (25:48):
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Wesley Lyon: like four years, and he had the same problem. (25:51):
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Wesley Lyon: Moved into a house, the pipe burst underneath. (25:53):
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Wesley Lyon: So now you're going to dig up the driveway, and he tells me, (25:56):
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Wesley Lyon: dude, what are you talking about? (25:58):
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Wesley Lyon: They've got new technology where they can push something through that will expand, (26:00):
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Wesley Lyon: and they don't have to dig up the driveway. (26:04):
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Wesley Lyon: He was like, it cost me five grand to get this done. And I'm like, (26:06):
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Wesley Lyon: I'm 25,000 in. I haven't had the driveway repaved yet. (26:09):
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Wesley Lyon: I'm like, what in the world? (26:16):
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Mario Santiago: That's the problem in a lot of these things. It's like you as the consumer, (26:18):
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Mario Santiago: you don't know these things, right? (26:21):
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Mario Santiago: So historically, people trusted the advice that they were getting. (26:23):
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Mario Santiago: And the problem now is there's money and incentives behind the advice where (26:27):
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Mario Santiago: you don't trust it anymore. (26:31):
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Wesley Lyon: No, definitely. So yeah, no, it's a tough one. I don't think it's good for... (26:32):
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Wesley Lyon: Anybody, except for the people running it. And as you said, in this article, it really gets into it. (26:39):
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Wesley Lyon: And I did like they had some they had some data, they did admit that their data (26:45):
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Wesley Lyon: set is limited, because this stuff isn't as publicly well known. (26:49):
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Wesley Lyon: I think the returns to the investors were what they're supposed to be, (26:52):
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Wesley Lyon: they'd be a little more publicly well known. (26:55):
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Wesley Lyon: But yeah, they were like, I think over a 10 year stretch, you got like half a percent more. (26:59):
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Wesley Lyon: And they acknowledged that they thought their data set was skewed to the positive, (27:04):
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Wesley Lyon: but you got half a percent more than just investing in the S&P 500. (27:08):
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Wesley Lyon: And their point was a lot of this is more driven by just market returns than anything. (27:12):
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Wesley Lyon: As company values go up, you can get it in the public markets, (27:17):
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Wesley Lyon: you can get it here, but that return, we don't know if it's pre-management fees, (27:20):
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Wesley Lyon: post-management fees, what's going on. (27:24):
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Wesley Lyon: Everybody acknowledges that there's a level here of the onion that isn't unpeeled (27:26):
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Wesley Lyon: for most people. So, in general, it's just a ton of risk to take for a marginally maybe better return. (27:30):
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Mario Santiago: But you potentially lose everything. Yeah, yeah. Well, at least we got a positive from it. (27:39):
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Mario Santiago: You probably won't make that mistake with your driveway again, (27:43):
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Mario Santiago: and at least I learned from it, you know, next time it happens to me. (27:45):
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Wesley Lyon: But I think the American people are turning to some extent, and they really (27:49):
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Wesley Lyon: want a local person. They want somebody who's running the company who's also, (27:53):
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Wesley Lyon: you know, owns it, that's there to oversee it. (27:58):
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Wesley Lyon: Like, I found a new plumbing company, and I called them up, ran into another issue. (28:02):
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Wesley Lyon: You know, they come out, and they're like, hey, we have a $150 fee, (28:07):
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Wesley Lyon: and, you know, if we have to do any work, the $150 is credited against it. (28:10):
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Wesley Lyon: So, they show up. They figured out the problem within 30 minutes. (28:14):
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Wesley Lyon: They said, look, you don't have a major problem, and they're like, (28:17):
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Wesley Lyon: we're not even going to quote you because it's under the $150. (28:20):
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Wesley Lyon: We just need this part, a little bit of labor. (28:22):
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Wesley Lyon: So you're going to be, you're going to get the $150 visit fee for an emergency (28:24):
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Wesley Lyon: visit. And that's all you're paying today. And I was like. (28:29):
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Mario Santiago: Awesome. Great. This is amazing. Last time I called a plumber. (28:32):
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Wesley Lyon: You know, they were digging up the driveway for apparently no reason. (28:36):
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Wesley Lyon: And these guys, you know, just like, no, no, no, we don't do that. (28:39):
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Wesley Lyon: You know, we're here. We privately held company, you know, this guy owns it (28:43):
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Wesley Lyon: and he'd be down our throats if we sold you something that we didn't want. (28:47):
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Mario Santiago: Yeah. It's a reputation. (28:50):
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Wesley Lyon: No, definitely. But yeah, no, it's definitely something I recommend staying (28:51):
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Wesley Lyon: against in, you know, there's a lot of investments out there like this. (28:55):
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Wesley Lyon: So it was actually part of, I've got this article or our newsletter right here. (28:59):
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Wesley Lyon: So if you don't subscribe to the McGill and Lyon Dental Advisory, (29:04):
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Wesley Lyon: Highly recommend. Go subscribe. If you go to mcgillhillgroup.com, (29:08):
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Wesley Lyon: you'll be able to find the newsletter, sign up, make sure you're getting this. (29:12):
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Wesley Lyon: Every month you get valuable information on what you should do and what you (29:16):
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Wesley Lyon: shouldn't do. And every dentist really needs this. (29:20):
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Wesley Lyon: But then our last point as we go into this, why does this still exist with the benefits? (29:23):
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Wesley Lyon: And you mentioned the tax ramifications. And I kind of wove that in until a (29:29):
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Wesley Lyon: lot of politicians are tied up in private equity, and that's not an accident. (29:34):
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Wesley Lyon: So, do you know what they actually call this issue? (29:38):
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Mario Santiago: The tax loophole thing? Oh, man. No. (29:42):
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Wesley Lyon: Carried interest. (29:46):
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Mario Santiago: Carried interest. (29:47):
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Wesley Lyon: So, we've had a whole lot of polarizing elections recently, so it hasn't come up. (29:48):
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Wesley Lyon: But this came up big time in the Obama-Romney one, because Romney's a private equity guy. (29:53):
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Wesley Lyon: Bush was a private equity guy. Cheney. Obama has some private equity connections. (29:59):
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Wesley Lyon: I mean, it's everywhere. The senators, the congresspeople, everywhere, their connections. (30:04):
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Wesley Lyon: And the real thing is what they're able to do is this money they make in their (30:08):
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Wesley Lyon: fees and their profit split, especially the profit split, they're able to call (30:13):
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Wesley Lyon: it long-term capital gains and something we call carried interest. (30:18):
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Wesley Lyon: So if we went out and we were able to make $50 million in a year, (30:21):
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Wesley Lyon: which we would never rip our customers off to that extent, that's insane. (30:26):
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Wesley Lyon: But if we made $50 million in a year, we'd have to pay ordinary income tax, (30:31):
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Wesley Lyon: like every dentist listening to this. (30:35):
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Wesley Lyon: But no, they do it and a lot of times they get to call it carried interest and (30:37):
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Wesley Lyon: they just pay capital gains tax of 20 percent. (30:41):
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Mario Santiago: And I'm guessing these politicians are in the highest tax brackets. (30:44):
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Wesley Lyon: It's so funny. I always love it. We don't care what side of the aisle you're on. But if you, (30:48):
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Wesley Lyon: You've been in Congress for 20 years making $200,000 a year, (30:54):
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Wesley Lyon: and you have a $200 million net worth? (30:59):
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Wesley Lyon: I'm sure carried interest has nothing to do with that because every election, it's this hot topic. (31:02):
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Wesley Lyon: We're going to shut down carried interest, shut this stuff down, (31:08):
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Wesley Lyon: and then the election happens, we move forward, and we never hear another peep about it. (31:10):
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Mario Santiago: And they're basically cutting that tax bill in half, right? Because if they're (31:15):
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Mario Santiago: at the top tax bracket plus state, you're 40% or above, but you're paying 20% on the capital gains. (31:18):
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Wesley Lyon: You're saving 17% right off the bat. So, phenomenal for people that work in (31:24):
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Wesley Lyon: private equity, not an investment we recommend getting into. (31:29):
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Wesley Lyon: But Mario, any other closing thoughts? (31:34):
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Mario Santiago: No, I think those are good ones to talk about. (31:36):
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Mario Santiago: And like you said, we'll take a deeper dive at how it affects dentistry in the (31:39):
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Mario Santiago: next episode. But I think it's really important to understand what private equity (31:43):
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Mario Santiago: is and why people invest in it and why maybe not to invest in it. (31:47):
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Wesley Lyon: Yeah, well, tune in. Make sure you hit the subscribe button if you're listening to us. (31:52):
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Wesley Lyon: Make sure you get that next episode out. We're going to talk about private equity (31:56):
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Wesley Lyon: in dentistry, something we talk about a lot. (31:59):
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Wesley Lyon: But I think it's always a hot topic and the tides are shifting a little bit now. (32:02):
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Wesley Lyon: And, you know, hopefully if you've been listening to us for a while, (32:07):
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Wesley Lyon: you've understood that this stuff is what goes on. (32:10):
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Wesley Lyon: It's just I found it a little fascinating that it's publicly out there. (32:12):
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Wesley Lyon: So we for next episode we've got (32:17):
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Wesley Lyon: some great public nuggets we found that weren't on dental (32:21):
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Wesley Lyon: websites we're talking about just like consumable to the general public some (32:24):
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Wesley Lyon: things about what's going on and i think they even did an investigation in congress (32:29):
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Wesley Lyon: so that's going to be fun to talk about we're really looking forward to it thank (32:35):
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Wesley Lyon: you all for chiming in and we'll be with you next time. (32:38):
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Mario Santiago: All right until next time. (32:41):
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