Private equity executives are largely pleased with the tax bill, but there are growing grumbles about how the change to interest deductibility isn't grandfathered in for existing loans.
- Primer: Under current tax law, corporations can deduct 100% of interest on their debt. The new bill limits that deduction, and further strengthens the limit after four years.
Bottom line: This could be a particularly acute problem for highly-leveraged companies that are either unprofitable or barely profitable. In those cases, private equity sponsors may have to choose between pumping in new cash and crossing their fingers.
- Going forward, expect leverage levels to decrease. Per one buyout big: "We use leverage as a tax shield, which is about to become much less relevant."
- There is likely to be a decline in dividend recaps, at least in the short-term.
- To be clear, private equity firms are still cheering these changes (at least from a portfolio perspective).
- The longer-term hold period to qualify for carried interest is unlikely to prevent firms from selling before three years, in the rare cases when applicable. Just expect the funds to essentially defer the carry.
- Go deeper: What you'll see under the new tax code.