United States

2020 Election preview: Private equity


With the election approaching, RSM is looking at the economic stakes and the key issues for various industries and sectors. This is one in our series of election previews.

The top policy issue for private equity

Taxes, taxes and more taxes. The Democrats have made it clear they intend to increase taxes on the wealthy and businesses. Trump’s 2017 tax bill lowered corporate and individual taxes and made tax law more beneficial to multinational companies. But federal spending has increased, even before COVID-19, and federal budgets will need additional tax revenues regardless of the election’s outcome. A Democratic White House could spur general partners who are holding onto gains in certain portfolio companies to sell ahead of schedule. Policies around who may invest in PE—whether wealthy Wall Street types or Main Street investors—will also be critical.

If trump Wins

Trump has voiced disapproval for the carried interest tax provision, which allows for PE capital gains to be taxed at 20% rather than at ordinary income rates of up to 37%. Meanwhile, the Trump administration has expressed deregulatory ambitions that would be advantageous to the businesses in which PE firms invest. A proponent of low interest rates, Trump has long been at odds with the Federal Reserve. Amid COVID-19 woes, the Fed has moved to an average inflation-targeting framework that will keep rate hikes off the table until 2025. This means the Fed will allow the economy to run hot upon a possible recovery, which bodes well for PE firms that can access cheap money. Trump has also discussed legislative action to lower taxes over time on capital gains by indexing them to inflation, a move that would benefit private equity if enacted.

If Biden Wins

Biden would raise the corporate income tax rate from 21% to 28%, making M&A less lucrative. He supports raising taxes on capital gains, which could hamper deals in the short-to-medium term. Biden would seek to normalize relations with China, which would spur bilateral investment, especially in manufacturing. The former vice president lists climate change as a priority issue and seeks to reduce emissions and invest in clean-energy technology and infrastructure, which would accelerate social impact investing. Democrats are likely to undo investor-friendly terms and disable Main Street investing in buyout firms. It remains unclear whether Biden will pick up the mantle for Senator Elizabeth Warren’s proposed Wall Street Looting Act, which would overhaul PE governance and provide more protections to workers when a company’s fortunes go south.

Other private equity issues:

Current industry dynamics—historically low interest rates, record amounts of dry powder, ample distressed assets—favor PE in the long term. We expect countless buying opportunities for well-priced companies. Ongoing uncertainty caused by the suppressed economic outlook has damaged confidence in the short term. To reconcile the difference between actual and perceived market prices, we expect to encounter a return of deal terms usually seen in recessionary environments, like deferred consideration mechanisms, indemnification, opt-out terms and earn-outs. The deep discounts in the market, exacerbated by many firms needing financing or wanting to offload troubled assets, could be the call to arms the industry has been waiting for.

Subsequent waves of COVID-19 infection present risk for either candidate. In either presidential scenario, the SEC will remain judicious in its oversight of asset managers. Risk areas such as undisclosed fees and expenses and conflicts of interest will be in the SEC’s focus, but the department has cited increased concern around valuation violations, disaster recovery, security and privacy due to the coronavirus. The technology and health care sectors are expected to receive the most PE allocations post-election, but in the long term, the sectors that have been hit hardest by the pandemic, such as real estate, hospitality and retail, may present the highest upside.

The Trump administration’s effect on the industry has been:

Mostly positive. Trump’s 2016 campaign stance was to simplify the tax code. This resulted in a reduction of the corporate tax rate to 21% and the creation of a maximum pass-through business tax rate of 29.6% if eligible for the full 20% qualified business income (QBI) deduction. During Trump’s tenure, private equity deal flow reached record highs in 2017, 2018 and 2019, when transactions rose to $858 billion. Deal activity has fallen sharply since the onset of the pandemic in March, and dry powder is at an all-time record high. In June, the Trump administration allowed 401(k) retirement plan investors to invest in alternative investments such as PE, a move that faced opposition from those who say these assets are too risky for everyday investors. Trump’s presidency has focused on protectionism, which concentrated on defending U.S. jobs and businesses from foreign competitors, in turn curbing international deals. The president has led a broad reduction in environmental regulation, but not enough to slow the enthusiasm for ESG or impact investing.

By the numbers: $1.5 trillion

This is the amount of PE dry powder available as of June 30. It is one of three factors the industry has in its favor; the other two are distressed assets and low interest rates. Whether  the United States maintains accommodative fiscal policies remains to be seen. Either way, PE is primed for an extended period of buying opportunity. The potential economic problems of 2020 are deeper than they were during the 2008 recession, but today’s crisis is not systemic. Uncertainty plays a more prominent role this time: A wide range of outcomes is possible, depending on how soon a vaccine is developed and who resides in the White House.

Actions private equity firms should consider:

In a time when the economy has slowed, PE is busier than ever managing through the COVID-19 crisis. From portfolio company cash flows and myriad operational threats to planning the next transaction, private equity firms are running in overdrive. RSM has leveraged its vast private equity network to gain insight into what’s on the minds of private equity professionals. This includes: portfolio cash flow analysis, transaction and IT advisory services, ESG and people advisory services, financial and technical accounting outsourcing, systems development and/or integration, and security and privacy analysis.

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