Blue Owl |
A sneakily important fact of finance is that if you make $10 million a year, you make $10 million a year, but if you own a company that makes $10 million a year, it’s worth at least, say, $100 million. A stream of income is worth some multiple of a year’s income, depending on things like interest rates and how risky the income is and how much it is expected to grow; I am going to use a multiple of 10x for simplicity but real numbers will vary. (The price/earnings ratio of the S&P 500 index right now is about 29.6x; a company with that multiple and a $10 million annual net income would be worth $296 million.)
This means that if you are in some money-making business, it might be a good idea to sell a portion of your business. If you make $10 million a year, and the right multiple on your earnings is 10 times, then you own a $100 million business. If you sell 20% of that business to someone else, then that gets you several benefits:
- You have $20 million to spend on houses, boats, etc., right now. (Of course, now you only get $8 million a year from your business; the buyer gets the other $2 million. But you get more money now.)
- You are richer than you were. Before you sold a stake, you were making $10 million a year; presumably you put some of that in the bank etc., but you were also paying taxes and stuff and it would take many years for you to accumulate $100 million. Now you have $20 million, and an 80% stake in a $100 million business; your net worth is $100 million more than it was. Of course this isn’t true; before selling the stake, you owned 100% of this same business, which was presumably worth $100 million. But no one is quite going to believe you that it’s a $100 million business until you sell the stake; selling the stake is what validates it as a $100 million business and makes you a centimillionaire. In particular, selling a minority stake of a business is a traditional way to become “a billionaire”: You have some high-eight-figure-ish annual income with good prospects for more,[1] you are rich but not a billionaire, but then you package that income into a company and sell a minority stake at a billion-dollar valuation and, bam, you get the “billionaire” title.[2] None of this is economically important — the income stream is what it is, etc. — but it can be psychologically important.
- You have taken some risk off the table: If the business crashes tomorrow, you don’t get your $10 million (or $8 million) a year anymore, but you get to keep the $20 million. Your new co-owner shares the risk of the business with you.
- You save on taxes. Probably the $10 million a year that you were making before was taxed as ordinary income, at relatively high rates. But when you sell 20% of your business for $20 million, that's capital gains: That's not income for your labor (taxed at high rates), but rather an increase in the value of stock that you own in your business (taxed at lower rates).[3] By selling a stake in your business you get to transmute ordinary income into capital gains.[4]
This is very straightforward stuff, but it is finance-y stuff; it is stuff that not everyone knows or thinks about. So there is a business of just going around to people who run their own prosperous businesses and telling them this. You run a private equity firm, you go to family businesses or doctors' practices or whatever, you say “hey you could work for the next 10 years and get paid for your work and pay taxes on your income, or you could sell a portion of that income to us in advance, get money now, save on taxes, and mark your wealth to market so you can tell people that you’re really rich.” And the doctors or whoever are like “huh I never thought of that, give me the money,” and you’ve got a good trade. The tax advantages alone — converting future ordinary income into present capital gains — can make it a good deal for both sides.
One thing is that, if you do run a private equity firm that does this sort of trade, a lot of your income comes in the form of recurring management fees on the private equity funds that you run. These fees are taxed as ordinary income, and the main purpose of most private equity managers' lives is to turn ordinary income into capital gains.[5] Another life purpose is of course becoming a billionaire. And so you might look around and say … wait a minute, I am buying stakes in family businesses so their owners can get nominally richer and optimize their taxes; who will buy a stake in my business so I can be nominally richer and optimize my taxes?
And the answer is Michael Rees:
Until Michael Rees became a billionaire this year, he was arguably the most popular man on Wall Street. ...
In little more than a decade the firm that Rees co-owned, Dyal Capital, has paid out well over $10bn to buy minority stakes in some of the best-performing companies in finance. He has forked out hundreds of millions of dollars to the founders of private equity firms including Silver Lake and Providence Equity; to hedge fund managers including Jana Capital; and to firms such as Golub Capital and Owl Rock, which are displacing banks as chief lenders to a swath of corporate America.
That is from this delightful Financial Times profile of Rees and Dyal, which “gives top financiers a way to convert their paper fortunes into cash and potentially lower their tax bills.”
But then if you are Michael Rees, and you are in the business of buying stakes in private equity firms so their owners can get nominally richer and optimize their taxes, you might look around and say … wait a minute, who will buy a stake in my business so I can be nominally richer and optimize my taxes? And the answer is a complicated three-way merger involving a special purpose acquisition company that allowed Dyal Capital to go public as part of Blue Owl Capital Inc.:
This year Rees, 46, became a billionaire in his own right. Having started Dyal in 2011 as an experimental division on the fringes of asset manager Neuberger Berman, he broke free of his parent company and pulled off a $12bn transaction that amounts to one of the biggest ever stock market debuts by a US private capital group. The enlarged company, known as Blue Owl, instantly achieved a market capitalisation close to that of Carlyle Group, Ares Management and other more established rivals.
He “became a billionaire” in this strictly nominal sense: He had a stream of income before, and he has that stream of income now, but having sold a stake in it at a multibillion-dollar valuation, now he’s a billionaire.
Anyway the Blue Owl deal was hotly controversial because, if you are an alternative investment manager in the business of taking minority stakes in alternative investment managers, eventually there are going to be conflicts of interest. Specifically, Dyal owned stakes in a couple of private credit funds called Sixth Street Capital and Golub Capital, and the three-way merger that created Blue Owl involved not just a SPAC but also another private credit fund named Owl Rock:
Even some executives close to the deal acknowledge it appears rife with conflict.
A Dyal fund had previously invested $500m in Owl Rock, before it merged with Dyal. It meant that Rees and Ward were now managing a fund that is also one of the biggest shareholders in their own firm. While the investors in Dyal’s funds are still waiting for an opportunity to cash out, the stock market listing has already given Rees and Ward big payouts of their own.
The sharpest objections came from executives at Sixth Street and Golub Capital, who were unhappy that Dyal — one of their biggest shareholders — was merging with Owl Rock, one of their most formidable rivals. They characterised the transaction as a “betrayal” that would put their confidential financial information in the hands of a competitor. And insisted that their deal with Dyal gave them a power of veto.
It did not. Golub and Sixth Street sued, claiming that transfer restrictions in their contract with Dyal prevented Dyal from merging; Delaware and New York courts disagreed. Also the worries about betrayal do not seem particularly real; the Delaware court found that “this litigation and the parallel action in New York were part and parcel of a calculated effort to ‘muck up’ the Transaction to force a buyback” of Dyal’s stakes in Golub and Sixth Street on cheap terms:
After learning of the Transaction, in December 2020, Sixth Street’s senior executives assured their investors that the Transaction would have “zero impact on our business” because Dyal III was a “completely passive investor” run by “good folks.” And importantly, they emphasized that Dyal “[does not] get competitively sensitive information from us in any real sense,” and that “whatever information they [Dyal] get will be manag[ed]” with “informational firewalls.” Accordingly, David Stiepleman, Sixth Street’s Co-President and Chief Operating Officer, stated that he was “not particularly concerned about the theoretical possibility of [Owl Rock as] a smaller firm in the credit space seeing [Sixth Street’s] info.” Sixth Street reiterated its lack of concern on multiple occasions, assuring investors that Dyal III was a “[p]assive 10% owner of Sixth Street” and there was “nothing [to be] concerned about at all” with respect to the Transaction. …
Since filing, nothing in the record indicates Sixth Street ever actually became concerned about its confidential information. ... In his deposition, Alan Waxman, Sixth Street’s CEO, testified that “[Blue Owl is] not getting our pipeline. They’re not going to be involved in our investment process.”
It’s good to sell a stake in your business to get cash and be rich, but the downside is that if your business keeps growing, you have given up some of the upside. If you can buy it back cheap, you might as well try.
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