Here's why Biden's election may not spur a rush of year-end PE deals

Dealmaking in private equity faces a big question mark at year-end.

In recent weeks, a wave of industry professionals have predicted that PE firms would try to execute a rush of last-minute deals over the final weeks of 2020 to lock in gains before possible increases to the corporate tax rate and closure of the carried interest loophole under President-elect Joe Biden.

After all, it has happened before. When President Barack Obama proposed ending the carried interest loophole early in his first term, private equity deal count rose 34% in the fourth quarter of 2010, according to PitchBook data, which was the final quarter before the law could have gone into effect. Fortunately for private equity firms, the proposal never gained enough bipartisan support to pass, despite repeated attempts from the Obama administration.

This year, however, the prospects for possible tax increases under a new Democratic administration are more complicated.

Nearly a month after the election, it remains unclear whether Biden will have the benefit of passing tax legislation with a Democratic-controlled Senate, or whether Republicans will maintain control of the chamber. The answer will have to wait until Jan. 5, when two runoff elections for both of Georgia's seats will settle the Senate's last undecided races. US private equity exits

That leaves private equity in a precarious spot. Biden's tax plan would raise the corporate rate from 21% to 28%, and the carried interest tax, which is typically treated as capital gains and taxed at around 20%, would instead be taxed as income. Increasing the corporate rate could limit companies' free cash flow, hindering the ability of firms to strike deals during Biden's presidency.

The latter change would effectively double carried interest tax on high-earning private equity partners, since Biden's plan would raise income tax on individuals making more than $400,000 a year from 37% to 39.6%.

But actually passing that tax plan is far from certain in a Senate that Republicans still lead 50-48.

The Senate would only flip blue if Democratic challengers Jon Ossoff and Raphael Warnock can prevail over incumbents David Perdue and Kelly Loeffler, respectively. A 50-50 split means Democrats have the edge, with Vice President-elect Kamala Harris serving as the tie-breaking vote.

And any tax measures that pass may not even go into effect until toward the end of 2021.

"I don't think it's likely," Wylie Fernyhough, a PitchBook analyst who covers private equity, said of a possible holiday deal rush. "It'll take the administration nine months to a year to get the new legislation in, and then it likely won't take effect until 2022, giving private equity firms all of next year (to make deals)."

To be sure, the PE industry could still see an increase in dealmaking at year-end but that may say more about the pandemic than it does about politics. The arrival of vaccines in the coming months has renewed hopes for a return to normalcy.

But there are also signs that the ending the COVID-19 chill on some deals is far from over. Infection case counts continue to rage across much of the world, creating even more uncertainty for companies and investors about the short-term financial picture.

Moreover, lenders have been more aggressive in pushing for favorable terms for private equity-backed deals, according to Patrick Donegan, an executive at Performance Improvement Partners, which consults PE-backed companies on technology. As a result, receiving financing has become a challenge for even well-established investors.

"In its simplest form, they're OK to now lend some money, but probably not as much as they were comfortable with in the past," Donegan said of banks. "And therefore, the equity sponsors have to write a little bit larger check to get deals done."

With around $1.5 trillion in dry powder, private equity firms in the US have plenty of firepower. But many companies simply aren't for sale. Private equity exits are expected to hit a 10-year low in 2020, PitchBook analysts said in their Q3 2020 US PE Breakdown. That means more firms are opting to hold companies until there's more economic certainty. In other words, it may be a few more months before there's an opportunity for the long-rumored deal surge.

"You may see wealthy families look to sell as their personal taxes go up, so PE could buy," said PitchBook's Fernyhough. "But PE won't be a forced seller."

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