PitchBook Explores Impact of Reduced US Corporate Tax Rate on Private Equity

SEATTLE, NEW YORK, SAN FRANCISCO and LONDON, June 29, 2018 /PRNewswire/ -- PitchBook, the premier data provider for the private and public equity markets, today released a new report entitled, From IRS to IRRs, which examines how the Tax Cuts and Jobs Act (TCJA) of 2017 will impact the private equity (PE) investment landscape. To do so, PitchBook analysts evaluated specific changes outlined in the legislation including the headline tax rate, interest deductibility, net operating losses, capex depreciation, international taxation and carried interest. While the reduction in the corporate tax rate from 35% to 21% is expected to benefit PE overall, each sector will have varying levels of benefit in the short- and long-term. What's clear from the landmark tax legislation is GPs will need to adapt strategy and deal structure to stay competitive in today's market.

To download the full report, click here.

"The reduced corporate tax rate is a win for most LPs and GPs, however, the sunset clauses down the road will further tighten the financials for many platform companies. In addition, changes to interest deductibility will especially hurt highly levered and capex-intensive companies, such as those in the energy and materials industries, due to their higher depreciation expense. Yet, it's unclear whether industry professionals are fully taking this into consideration," said Wylie Fernyhough, analyst at PitchBook. "Overall, the tax cuts were intended to boost profitability by lowering taxes, which they do, albeit unequally. PE firms should be mostly pleased with the changes."

Report findings and key takeaways are outlined below:

• Upward Pressure on EV/EBITDA Multiples – The reduction in the US corporate tax rate will lead to an increase in free cash flow (FCF)—and subsequently, enterprise value (EV)—for most PE portfolio companies as tax payments decrease. Increased cash flows will put upward pressure on EV/EBITDA multiples and thus, increase PE deal sizes.
• More Conservative Use of Leverage – With interest deductibility now capped at 30% of EBITDA, many PE firms will limit leverage to 6-7x EBITDA as the interest deduction limitation has effectively increased the after-tax cost of debt under the new threshold.
• Delayed Exits Due to Carried Interest Changes – New carried interest taxation requires a three-year hold period to realize long-term capital gains rates on carry, therefore, the number of exits occurring within the first three-years of PE ownership are expected to decline.
• Uptick in Carve Outs and Divestitures – Under the new tax code, seller tax payments drop by 40%, making large conglomerates more willing to pursue carve-outs and divestitures. This, in turn, will create additional deal sourcing opportunities for PE firms.
• Portfolio Companies Restructured to C-Corps – Various changes to the tax code have increased the comparative benefits of C-corp structures as opposed to flow-through structures.
• International Expansion – The transition from a worldwide tax system to a territorial system reduces foreign taxes on middle-market companies doing business internationally, thus making international expansion and add-on deals more attractive to PE investors.
• Capex tradeoffs – While capex-intensive businesses are expected to benefit from the new tax code in the near term, interest deductibility will be reduced to 30% of EBIT in 2022 and the capex bonus deductions will be phased out.

Readers can access the full report and findings by clicking here.

About PitchBook
PitchBook is a financial data and software company that provides transparency into the capital markets to help professionals discover and execute opportunities with confidence and efficiency. PitchBook collects and analyzes detailed data on the entire venture capital, private equity and M&A landscape—including public and private companies, investors, funds, investments, exits and people. The company's data and analysis are available through the PitchBook Platform, industry news and in-depth reports. Founded in 2007, PitchBook has offices in Seattle, San Francisco, New York and London and serves nearly 16,000 professionals around the world. In 2016, Morningstar acquired PitchBook, which now operates as an independent subsidiary.

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SOURCE PitchBook

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