You can't keep a good idea down
Why the government will never be an existential threat to a good business
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And now: regulation.
An early theme that has cropped up in writing this newsletter is that everyone knows everything. The answer to just about every question is a Google search away, and this makes finding novel solutions to problems harder than ever because already commoditized knowledge, expertise, and know-how becomes increasingly commoditized.
A corollary to everyone knows everything is that anyone can know anything.
Which makes this next one even more embarrassing.
“plz read, tx”
One of the most shocking New York-centric pieces of news I can remember is news earlier this month that broker fees for rentals would be banned.
For those who do not live in New York, here’s what happens when you rent an apartment in this city: you put down one month’s rent for the security deposit, pay the first month’s rent (maybe last, too, depending), and then cut a check for 15% of entire year’s rent to a broker.
Sometimes, this person does something. A broker could find you a place they heard through a connection is showing just today and so you get to scoop it up before the listing hits StreetEasy. In these cases, a broker is worth it.
The first apartment I lived in in the city was rented to me for probably 20% less per month than it should’ve been because I found it on what amounted to a one-day clearing sale. I later moved out because the landlord offered me a renewal rate that was 35% higher than the prior year’s monthly rent. This was probably illegal. Which is fine: the apartment was gross anyway.
In other cases, a broker might just look at StreetEasy for you. Which, I guess, is helpful, but also 15% of an entire year’s rent seems like a lot for this? Sometimes, as was the case with my current apartment, the broker simply wedges themselves between your own apartment search and your desire to live in a certain place. The fee for that is still 15% of the whole year’s rent.
But so these fees have been outlawed, the grift is over (though just not quite yet).
In the Times last week, an opinion piece made the very personal appeal that the writer’s husband, a real estate broker, was definitely not one of the bad brokers and would be harmed by this new regulation. And this, of course, is what happens when rules change: someone loses.
My own view isn’t super strong. Again I’ve worked with a decent broker and I’ve worked with a bad broker. “Some good, some bad,” is a pattern that repeats so often during your life it’s hard to know when to really draw the line.
But as Neeraj Agrawal noted in his newsletter a few weeks back, the lobbying group that works on behalf of New York real estate brokers was blindsided by this new law. Obviously, if you’ve got a lobbying group that is supposed to fight for the stuff that a certain profession needs to exist it is inexcusable for the leader of that group to say they were blindsided by the new regulation. And yet this is exactly what happened.
The Times writes that this new law was “buried in a legal guidance on last year’s rent laws, caught lawmakers, many landlords and brokers off guard.” Now, I have little doubt that the New York real estate lobby is choosing its representatives in some extremely clubby way that will never, by design, surface the best possible expert to fight for the group’s wants and needs. Corruption and carelessness are synonymous with New York real estate. Take the act far enough and they’ll make you president.
But when anyone can know anything, you’re going to have even less sympathy for the only person (in this case, people, which makes it even worse) who is supposed to know something not knowing it. The internet allows anyone to become an expert on anything. But a lower bar for becoming an expert raises the bar for remaining one.
Broker-gate, however, isn’t only a story of people falling asleep on the job, but also a reminder that the government can and does change its mind. Politics often makes interesting bedfellows, and so here we are: DTC startups and real estate brokers are now aligned against government interference. Or… are they?
The razor’s blunt edge
Earlier this month, the FTC made the surprising announcement that it would file to block Edgewell’s $1.4 billion acquisition of Harry’s. You’ve probably heard of the latter company but maybe not the former, except you have: Edgewell owns Schick, Banana Boat, and Wet Ones wipes.
The reaction has been fascinating — Edgewell shares are up about 30% since the announcement. Which makes it pretty clear Wall Street investors are happier seeing their old-line consumer goods company focus on being an old-line consumer goods company instead of pivoting towards trying to be a cool, growing brand.
On the other side, Harry’s has now basically lost a year of its corporate life believing it would be in charge of remaking legacy brands, growing its namesake brand, and doing so with tons of resources. The company and its management are now forced back into living a startup life again.
When you think about the youth of Harry’s as a company, the lost time to this not-happening merger is quite jarring. Founded in July 2012 and taken out by Edgewell in May 2019, Harry’s has spent basically one of its seven years in existence in either the courting phase or post-announcement planning phase of this merger. Just about 15% of the company’s entire history was focused on not really being Harry’s — and the most recent 15% of its history at that — and now the entire focus must be undone. Also: Harry’s didn’t get a breakup fee, and will now be mired in litigation with Edgewell.
It’s hard to say, in the immediate wake of this deal getting squashed, which company has a more challenging path forward right now. Organic sales at Edgewell fell more than 3% in its most recent fiscal year, the year during which they decided to take out Harry’s. Harry’s, while certainly facing a difficult cultural and internal re-focusing, still has most of the brand equity (in addition to actual capital raised and growing sales) that got it this far.
Would you rather be the business in secular decline with a larger brand portfolio and a balance sheet you can lever and re-lever, or the startup that has gained market share, mindshare, but needs a new plan to get fresh cash into the business?
Harry’s, of course, is now about to find out just how good its business really is. But perhaps more significantly, its peers and challengers are going to be answering that same question more urgently. And all parties are being prompted by the government.
As Dan Frommer at The New Consumer wrote in the wake of this news:
The bigger picture is that this ruling highlights a serious, relatively unexpected strategy risk for many consumer startups — particularly the ones that are successful enough that they cause shifts in industry dynamics.
Most single-brand startups that have been launched in the past decade were designed to be sold, and primarily to the incumbents in their fields. Few will be successful or profitable enough to last on their own or go public. [...]
Harry’s will be fine… But the lesson for most others — from this, but also the WeWork fiasco, Casper IPO valuation haircut, etc. — is clear: Get profitable early, grow more from sales than from overfunding, raise less cash, and if you must sell to your incumbent, probably sell earlier in the cycle, before you run out of options.
And as is almost always the case in life, that final idea of optionality is the most important one.
And it sits at the heart of the argument that the government can’t kill a good business, and if it does the business was never any good. Any person, company, brand, etc., that is in a strong position will have a level of optionality, whether they pursue these choices or these decisions are forced upon them.
Just asking questions
So in what is probably not an unrelated move, the FTC this week asked big tech firms for information on all of their mergers over the last decade.
These inquiries were marketed under the guise of the FTC just wanting to learn about what happened in these deals — FTC Chairman Joe Simons told the Wall Street Journal: “This initiative will enable the commission to take a closer look at acquisitions in this important sector, and also to evaluate whether the federal agencies are getting adequate notice of transactions that might harm competition.” — there is a non-zero chance the government could move to undo these mergers.
But if Amazon, Facebook, or Apple were forced to spin off businesses they’ve purchased in the last few years or split up the company because of a government order, it would be a monumental annoyance but not existential to either company. The sell side analyst, CFA Level II dream probably is a government order that requires Facebook or Amazon to break up all of their units, news that would bring every possible sum-of-the-parts analysis into play.
So but if we agree that Amazon and Facebook are good businesses that can’t be killed by the government, I think we agree that being a real estate broker is a bad business that can be.
Government regulations are a risk to every company in every industry (you can read literally any 10-K and see this for yourself), but the only businesses that face existential threats from the governments are one-sided regulatory arbitrages that can be eliminated by a single piece of focused legislation. Some of the best businesses in the world are government contractors, but these relationships aren’t one-sided bets on legislative laziness. Building your business around a government action is different than having your business imperiled by one.
The optionality embedded in the New York broker’s 15% fee on rentals wasn’t a decision tree but a yes/no: if nothing changes it exists, if one thing changes we die. Building a career and a business on the back of this regulatory arb isn’t a business at all. It’s just a temporary hack.
Any good business will be able to withstand large changes to the assumptions underwriting the basic idea. A good business can deal with a scuttled merger, a forced breakup, or a high-profile rule change.
But if one change unravels an entire company or industry it means it wasn’t any good to begin with. And that’s something everyone should know.
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1. It seems like most things in New York real estate are, in some way, illegal.
2. Which is how bad things happen! But what can I do: I’m only human.