We are inside 100 days until the presidential election, and no matter one’s political affiliation there’s a lot riding for businesses and the economy on the results from November 3.
For the private equity marketplace, hollowed out by the COVID-19 pandemic and the drying up of leveraged lending, the signals we get on the first Tuesday of November may tell us whether PE limps to the end of a year to forget or finishes with a flurry that retrieves hope and momentum from the ashes of 2020.
PE deals have suffered in lockstep with most other sectors from the profound uncertainty that settled over the economy after the COVID-induced shutdowns of mid-March. With companies unable to predict the revival of demand, lenders could not lend, buyers could not buy, and sellers could not sell. The marketplace ground to a halt and emptied out like so many big-city downtowns.
In this strange, new private equity world, there are some fresh and unexpected players with the potential to rekindle the market. They possibly include COVID-battered companies in dire need of investors, renewable-energy sectors that rely on favorable government tax policies, and ESG (environmental, social, and governance) businesses with strong fundamentals to match their compelling ethical missions.
But one scenario that could really light a fire under PE deal-making in the latter part of the year is the prospect of higher taxes. It is reminiscent of the expiration of President George W. Bush-era tax cuts in the final months of 2010 and 2012. Those expirations drove a burst of M&A activity as buyers and sellers sought to reap maximum after-tax proceeds before rates went up. We may be girding for a repeat.
Current polls suggest that Democrats could retake the White House and the U.S. Senate. Joe Biden and Progressive members of Congress such as Sen. Elizabeth Warren have proposed rolling back the Trump individual and corporate tax deductions. They also have proposed nearly doubling the long-term capital gains tax on individuals and substantially increasing the corporate income tax rate. The recently unveiled Biden plan includes a Social Security tax on high earners and potential changes to tax regimes concerning foreign earnings and estates.
Democrats have also set their sights on closing a long and contentious political debate by taxing carried interest as ordinary income — which would amount to nothing less than a strike at the heart of the private equity model. A number of states are also considering hefty tax increases. A sale in 2020 at an enterprise value of 90 could net the owners substantially more after taxes than a sale at 100 next year or the year after.
The upshot is that a lot of PE players are starting to assess which way the political and fiscal winds are blowing and to work on getting deals done before potentially significant changes to the tax regime.
Which investors look the likeliest to wade into the PE marketplace with an eye on possible adverse tax consequences if they don’t? Here is what my quarter-century in the field, in good times as well as turbulent, tells me:
Family-owned and entrepreneurial businesses may seek an exit, even with depressed valuations, along with PE-owned portfolio companies in which investors are substantially “in the money.”
Bread-and-butter company roll-ups involving entities such as local service businesses and niche brands that aren’t particularly sexy or cutting edge but make money and need capital for expansion and growth.
“Made in America”: as the political desire grows for more goods to be manufactured stateside by American workers, production and even service businesses that make that pledge will find an easier path to needed capital — and may find tax, trade, and other regulatory advantages.
Many companies hit hardest by the pandemic, such as in retail, transportation, and hospitality, are in grave need of capital; such deals could be pegged to longer-term secular trends or might amount to short-term turnarounds or comebacks.
Sound environmental, sustainable, and/or good-governance policies are sometimes in the eye of the beholder, but companies that integrate financial returns with social outcomes should be able to attract investor interest.
Deals driven or underpinned by government policy — including renewables and other aspects of green technologies — should be viewed favorably in a resurrected PE market.
It is impossible to predict the course of the campaign, or the economic leverage the winner (or winners, if the government remains divided) might boast. A change of course in tax policy might not in the end be as far-reaching or complete as Democratic proposals advocate.
The ongoing effects of the coronavirus pandemic are easier to envision, as is their influence on the PE market as we get closer to understanding the virus and perhaps developing a vaccine. Private equity cannot remain dormant — there is too much money sitting on the sidelines and too many places where it could do good, helping reverse the terrible economic costs of the pandemic, including bringing large numbers of unemployed back into the workforce and jump-starting consumer spending and other essential activity. Private equity has a role to play in righting the economy and the millions of lives the pandemic has disrupted, and there are lots of places to start.
Brian Richards is chair of the global private equity practice at law firm Paul Hastings. He can be reached at [email protected]