The private capital community is watching the new administration and Congress closely. Changes to the tax code and other financial legislation continue to unfold. The question is how significantly new provisions could force changes to private equity’s business model. And PE CFOs have been working on backup plans.
Confidence in capitalism is not a sure thing.
Senator Ron Wyden, the Oregon Democrat who chairs the Senate’s Finance Committee, proposed early taxing capital gains at the same rate as income. His Democratic colleague, Senator Elizabeth Warren of Massachusetts, has been reported to be considering reintroduction of the Stop Wall Street Looting Act, to target carried interest. Her bill would also seek to curb write-offs of interest on debt used to buy companies and would make PE firms liable for their portfolio companies’ employee pensions and other costs.
What’s more, the SEC under the new administration has been expected to become more aggressive in enforcing regulations and conducting audits. New Department of Labor guidance issued earlier this year is continuing to take shape to remove barriers for 401Ks, IRAs and other defined contribution plans to invest in PE. But the opportunity for private equity to put this multi-trillion-dollar market to work is not a given.
Worst case scenario fears in the headlines at the beginning of the year have calmed. But a steadier march on taxes globally with new headlines from the G7 and new reporting on tax rates for the wealthy mean PE should not get too comfortable.
Responsible CFOs, keeping their obligations to their investors in mind, need to consider how sudden and drastic changes can impact balance sheets.
There are obvious places to look to get lighter and stronger.
Strong CFOs are putting into motion the benefits of outsourcing middle- and back-office processes. Except for compensation – an unappealing choice – CFOs don’t have many other cost-cutting options for winning efficiencies in private capital. Luckily, with what’s being called “new fund administration,” the benefits of outsourcing go much further than cost-savings.
New fund administrators like 4Pines are more confidently leveraging new private capital technologies to make significant gains in quality and speed of service. Private equity finance teams that have the good fortune to be raising new, larger funds from new investors are using it as an opportunity to lean into automation while it’s easier.
The truth is while your own team may embrace the new automation technologies available, many of your partners may be reluctant to try something new. Even if technology makes your process better and easier, there is always a learning process and a psychological barrier. That’s why now is the best time to identify partners who aren’t doing this for the first time, know how the technology works through actual practice, and have curated the right solutions.
If a CFO feels they always have time to flip the switch on outsourcing and technology adoption later when the need is clearer, the carnage may be unbearable when the time actually comes.
New fund administration has introduced customized reporting, cloud-based client and investor portals, modeling tools, underlying investment data collection and other one-stop-shopping solutions for PE firms. These platforms don’t cost extra to install, integrate or maintain, bringing down overall costs.
Further, outsourcing over to teams who are expert in these technologies lets PE firms shift their administrative expenses off their balance sheets and share the investment with LPs who will be served better. With outsourced services shared across your LPs, the cost to each is nominal. Outsourcing also means a third-party is valuing investments, rather than the manager, giving an added level of assurance to LPs.
Winning either way
Legislative proposals on the table require CFOs to evaluate their options. But finding and adopting higher quality services and becoming more efficient helps in all markets. It’s just that sometimes it’s hard to lift your head and look beyond immediate deadlines and see a way to make investments now that pay off with easier and better options overall.
But smart CFOs have been using the first part of 2021 and uncertainty in Washington to make the changes that will pay off.