Private equity has enjoyed a historically long business cycle alongside historically low interest rates. With high multiples and lots of dry powder floating around, today’s market bears some resemblance to that of 2005-2007, but not too much. It’s quickly becoming evident that the latest crop of funds (2016 vintages and later) will face both headwinds and tailwinds. We’ve partnered with Akerman, a law firm focused on the middle-market, to spotlight the sub-$1 billion fund market and examine how PE may or may not benefit.
The obvious tailwind, of course, is the reduction of the corporate tax rate from 35% to 21%. Private equity benefits from this at the fund and portfolio company levels, both of which are structured as corporations and qualify for reduced tax bills going forward. Moreover, the tax overhaul may also impact limited partners as it relates to section 1202 of the Internal Revenue Code—with some foresight, LPs (and possibly GPs as well) might be spared the 23.8% federal capital gains tax on qualified portfolio company dispositions.
There are potential headwinds, as well. The Fed is expected to raise interest rates several times over the next two years, but PE returns shouldn’t be impacted as heavily as some fear, as long as the increases are done at a modest, structured pace. At the lower end of the US middle-market, M&A multiples below $200 million have moderated in the 7x to 8x range, visibly smaller than $1 billion-plus multiples. As rates rise, there’s a reasonable chance that multiples will come down in tandem. That bodes well for PE, which is struggling as an asset class to outperform the public market.
The public market, however, will likely come down to earth as cheap money starts to evaporate, providing an opportunity for PE to regain its luster. Quite a bit is expected from private equity—maybe too much. PE doesn’t hit as many grand slams as it used to, but perhaps it doesn’t need to. Relative returns might be a more appropriate measuring stick than absolute returns, at least for this latest batch of funds.
This column originally appeared in The Lead Left.
Read more about the middle market in PitchBook’s recent collaboration with Akerman.
Learn about our editorial standards.
