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Tax reform brings new challenges in PE sector

By newadmin / Published on Sunday, 11 Feb 2018 12:17 PM / No Comments / 4 views

“The tax bill itself doesn’t require any rework of our strategy, taxes don’t drive our investment decisions but are one of many factors we evaluate when making investments,” said James Guddy, managing director and cofounder of Watervale Equity Partners, which formed last summer. “However, we do believe that the tax bill is good for small business owners. If it’s good for small business owners, then we generally think it is good for us.”

The tax rules could persuade some firms to consider deals they might’ve passed on before, though.

Part of that could be a function of the competition for deals fueled by a bull market and piles of capital that need put to work. According to a January report by research firm Preqin, global dry powder levels currently exceed $1 trillion. Those levels follow a record 2017 for fundraising that saw $453 billion raised.

But the tax bill still could influence the financing structure in a deal and how a firm itself would be post-investment. It’s another factor firms are evaluating.

For instance, most firms want to finance a deal with debt, which they can pay off at a lower cost of capital and generate a higher return on equity. Because of limits on interest deductibility from the tax codes, though, funds may end up having to put more equity in a deal. That could impact rates of return. (Firms can’t publicly discuss expectations for returns because of regulations, so none interviewed in this story could comment on whether they see their outlook for returns affected in this environment.)

All this means eyes will be keenly focused on how a deal is financed.

“The structuring considerations do seem to be the most complex, and we are working with our consultants to understand all the implications,” Guddy said.

“This should make discussion with our bankers very interesting as credit agreements are drafted,” Rosen added.

Meanwhile, in this market, in which manufacturing is still a large part of the economy, the lower tax rates might help draw investment dollars by private equity funds.

“Maybe now there’s a little more appeal to a manufacturer sitting in Northeast Ohio that makes a lot of domestic products and sells them domestically,” Glazier said.

Those elements could also appeal when it comes to securing financing for an acquisition. Firms with global capabilities often saw value in foreign companies where tax rates are lower, or domestic companies with foreign operations.

“Someone who is domestic who doesn’t do foreign might’ve not been super attractive before,” Glazier said. “Overnight, they’ve become a little more attractive.”

So while overall investment strategies haven’t drastically altered, the new tax landscape may influence some firms to model different investments in different industries and “take a second look at something they might’ve looked at last year that might not have made sense at the time,” Glazier said.

“I think the smart firms with a sharper pencil will get a bit of competitive advantage out of this by recognizing some of these aspects and factoring them into how they bid for companies,” Neary said.

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