AIC 2017 Spring Report

AIC 2017 Spring Report

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  STATE OF THEINDUSTRY | SPRING 2017
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  2 ABOUT THE AMERICANINVESTMENT COUNCIL The American Investment Council (AIC) is an advocacy and resource organization established to develop and provide information about the private investment industry and its contributions to the long-term growth of the U.S. economy and retirement security of American workers. Member firms of the AIC consist of the country’s leading private equity and growth capital firms united by their successful partnerships with limited partners and American businesses. More information about the AIC can be found at investmentcouncil.org. AIC MISSION We advance access to capital, job creation, retirement security, innovation, and economic growth in the United States by promoting responsible long-term investment.
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  guide, and promotethe important work of our members. It is work that we believe in, because we see countless positive impact stories achieved by PE. Our member firms have helped secure the retirements of millions of hardworking teachers, firefighters, and police officers, bolstered endowments that will educate the next generation, and over the past ten years, private equity has invested over $3 trillion into American businesses. Through the unique alignment of interests PE firms have with their portfolio companies and investors, the industry has grown into an economic success. Every day, we aim to be the voice of PE in Washington, D.C., and beyond. As you read through the following pages, you will learn more about our work to discern key industry trends, safeguard the industry’s legislative concerns and ensure proper regulation of PE, and promote better public understanding of the asset class. I hope you enjoy our “State of the Industry” Spring Report. I also hope you share it with your colleagues, and help spread the word about the activities we have underway. With the industry continuing to grow, the need to present one, unified voice is essential. Thank you for your support. Mike Sommers President and CEO, American Investment Council 3 Ten years ago, the American Investment Council was established with a singular mission of defending the private equity industry against several ill-advised legislative proposals. Times have certainly changed. We have evolved into a fully representative industry association; focused on advancing opportunities for the many different firm types within private equity—global investment firms, middle market firms, fund-of-funds, and the law and accounting firms that assist our member GPs. Importantly, our mission has changed as well: We advance access to capital, job creation, retirement security, innovation, and economic growth in the United States by promoting responsible long-term investment. Our research, government affairs, public affairs, and membership services teams assist, LETTER FROM PRESIDENT AND CEO MIKE SOMMERS Mike Sommers President and CEO
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  Since 2011, wehave facilitated more than 400 MEETINGS between Members of Congress and portfolio company CEOs. Since 2012, we have helped publish over 100 OP-EDS & LETTERS from our members and industry allies in top publications to educate the public and policymakers on private equity. Each year we release 15+ REPORTS including 3 MAJOR STUDIES • “Private Equity: Top States & Districts” • “Public Pension Fund Analysis” • “Private Equity Investment and Local Employment Growth: A County-Level Analysis” We have produced more than 20 VIDEO CASE STUDIES to showcase companies that benefit from private equity investment. In 2016, we developed an industry-wide PRIVATE EQUITY WOMEN’S INITIATIVE, in collaboration with the National Association of Investment Companies. Since 2011, we have filed more than 80 COMMENT LETTERS with legislative and regulatory authorities in the U.S. and worldwide. Our members can now take part in up to 8 COMMITTEES & WORKING GROUPS and 30+ member events annually. We secured strong bipartisan support to PASS THE INVESTMENT ADVISERS MODERNIZATION ACT OF 2016 in the House of Representatives. This bill would remove duplicative regulatory burdens on the industry. In 2009, we developed the COUNCIL’S GUIDELINES FOR RESPONSIBLE INVESTING, in collaboration with our members. With tax policy, we consistently defend: • the CURRENT TREATMENT OF CARRIED INTEREST AS CAPITAL GAINS INCOME; • the CURRENT TREATMENT OF INTEREST DEDUCTIBILITY; and • the CURRENT TREATMENT OF PARTNERSHIPS. ACCOMPLISHMENTS 4
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  PRIVATE EQUITY RIDESTHE BUSINESS CYCLE | 5 Ken Mehlman, KKR AIC Chairman of the Board “The Council plays an integral role in developing and communicating the industry’s position on legislative and regulatory matters. We have directly benefited from participating in the Council’s legislative and regulatory updates, video case studies highlighting portfolio company successes, and the many peer-to-peer events they have to offer.” Lee Mitchell Thoma Bravo “The Council keeps me up-to-date on the industry. They produce excellent reports analyzing trends and fund performance and host member calls that help me stay informed.” Eileen Nelson Welsh, Carson, Anderson & Stowe “The AIC is the best source of information on regulatory developments available in the private equity world, bar none.” John Suydam Apollo Global Management 5
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  PRIVATE EQUITY RIDESTHE BUSINESS CYCLE The business cycle has a way of creating headwinds or tailwinds, as if one is picking up speed on a descent or trudging up the mountain stage of the Tour de France. Navigating the business cycle may alter the route but it does not change the destination. The last decade of private equity’s ride started with an uphill climb created by the global financial crisis. Fund managers kept a measured investment pace and held companies for longer periods while valuations were low. As equities priced higher and showed less volatility, activity rebounded with a flood of portfolio company exits. Record amounts of distributions ushered a robust phase of fundraising by incumbent and new firms. Last year, private equity firms began to shift gears. U.S. fundraising and exit activity, while still higher than 2014 levels, reversed course and fell to $187 billion and $321 billion, respectively. With record amounts of dry powder ($526 billion) held by private equity firms at the start of 2017, funds have plenty of fuel to boost the investment pace. However, a few risks may create bumps in the road. The biggest concern among fund managers and their investors is high valuations. In a recent Preqin survey, 49% of North American respondents named valuations as the biggest issue facing the market. On an annual basis, valuations have topped 9x EBITDA since 2014 and reached almost 11x EBITDA during the third quarter of 2016. High purchase price multiples reflect buoyant pricing in public markets, access to inexpensive debt, and heightened competition for deals from funds flush with fresh capital. Bronwyn Bailey Vice President of Research and Investor Relations 6
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  PRIVATE EQUITY RIDESTHE BUSINESS CYCLE | 7 Managers are exploring different routes to find attractive targets that are poised for growth. Some larger funds are moving downstream in search of middle market opportunities, creating more competition in this segment. S&P notes that middle market purchase prices rose to 10.7x in 2016, compared to the total average of 10x. With high valuations, deal activity and volumes have fallen. Despite cheap credit and plentiful dry powder, fund managers have started gripping the brakes rather than speeding to acquire pricey assets. The amount of capital invested by private equity firms dropped in 2016 to $653 billion, reflecting a reluctance by fund managers to invest at such high multiples. The second potential risk is rising interest rates. The 10-Year Treasury rate rose 80 bps between July 2016 and January 2017, and the Federal Reserve raised the Federal Funds rate in March. Higher rates make debt used in acquisitions more expensive. However, they can also be a positive signal. Rising rates reflect inflationary pressures and a tightening labor market, characteristics of a growing economy. More expensive debt may also force some potential acquirers off the road. Less competition will release the valve on upward valuation pressures. Source: S&P LCD Statistics Source: PitchBook Valuations Are Near Record Highs Equity/EBITDA Senior Debt/EBITDA Sub Debt/EBITDA OthersPurchase Price Multiple Deal Activity Fell In 2016 Capital Invested (Bil.) No. of DealsCapital Invested (Bil.) No. of Deals
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  8 | PRIVATEEQUITY RIDES THE BUSINESS CYCLE Source: Federal Reserve Economic Data The third risk that can slow the momentum towards more investments is uncertain corporate tax policy. The House Blueprint calls for corporate rates to drop to 20%, but also includes the elimination of many tax benefits such as the deduction of business interest (in return for 100% expensing of capital purchases), and the plan favors exporting companies over importing companies. The tax plan would be a significant overhaul of how the U.S. currently taxes companies. Expect lengthy debate and discussion of specific elements of the plan through 2017. The uncertainty of the tax code is creating difficulties for private equity firms. For instance, how do funds determine the value of acquisitions without knowing how the company will be taxed? Likewise, how might current tax proposals be implemented? One example is the deductions of interest on business debt. If it is reduced or eliminated, will the deduction of interest on debt taken prior to the new tax laws be grandfathered in, or phased out? How these changes take shape will ultimately become clearer as tax policy discussions progress. Private equity has historically shown its nimbleness to navigate sharp twists in the road. Indeed, the industry as a whole successfully traversed the bumps created by the financial crisis and developed new strategies to provide returns for fund investors. Valuations, interest rates, and tax policy are risks that may not be clearly visible early in the ride. The AIC will continue to illuminate the path ahead and lead the peloton of private equity firms toward the finish line. Interest Rates Are Steadily Increasing
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  “The key forprivate equity is to make sure there is no fundamental damage to normative tax law that has enabled economic growth and investment over the long term.” NEW LEGISLATIVE AND REGULATORY CHALLENGES AND OPPORTUNITIES FOR PRIVATE EQUITY IN 2017 Elections have consequences. Never was that more true than in 2016. President Trump’s come-from-behind victory last November, combined with Republican majorities in both the U.S. House of Representatives and Senate breathed new life into the prospects for comprehensive tax and regulatory reform. Since the election, we at the AIC have frequently been asked to opine on what the most direct implications will be for private equity. My response has always been that the Trump Administration, working with a Republican Congress, could prove challenging on tax policy that is important for the industry while at the same time result in a more reasonable regulatory environment. With the Trump Era underway, it makes sense to assess the current legislative and regulatory challenges and opportunities that exist for private equity for the remainder of 2017, and what the AIC is doing to ensure that the best possible results are achieved for the industry. Jason Mulvihill General Counsel 9
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  10 | PRIVATEEQUITY RIDES THE BUSINESS CYCLE10 | NEW LEGISLATIVE AND REGULATORY CHALLENGES AND OPPORTUNITIES FOR PRIVATE EQUITY IN 2017 TAX REFORM—RISKS AND OPPORTUNITIES The Trump Administration and Congressional Republicans have made enacting tax reform one of three top priorities for 2017. Although the initial hortatory deadline of sending a bill to President Trump’s desk for signature at the start of the August recess is likely to slip, tax reform of some kind will likely advance this year. The key for private equity is to make sure there is no fundamental damage to normative tax law that has enabled economic growth and investment over the long term. Specifically, private equity must not only actively defend carried interest capital gains, but also work to ensure that to the greatest extent possible interest deductibility is maintained, and that pass-through businesses are not discriminated against in tax reform. At the same time, private equity should remain open to the positive changes that tax reform could bring not only for the industry but for the economy overall. In the context of tax reform, carried interest capital gains remains at serious risk for private equity. As a candidate, President Trump called to change the tax treatment of carried interest capital gains for “hedge funds.” Congressional Democrats persistently advocate for a carried interest tax increase that applies to everyone. To respond to this threat, the AIC and our partners have aggressively expanded our education efforts and outreach to key members of the Administration and important congressional leaders. The goal is to keep a discriminatory tax increase on carried interest capital gains out of any tax reform legislation. In this effort, we have been helped by several key Republican leaders in the House and Senate, including Representatives George Holding (R-NC), Carlos Curbelo (R-FL), and Richard Hudson (R-NC). In addition, a variety of national and state-based think tanks and policy advocates have registered their sustained opposition to increasing taxes on carried interest capital gains. For example, in early March more than thirty-two think tanks sent a letter to Speaker of the House Paul Ryan (R-WI) and Ways and Means Committee Chairman Kevin Brady (R-TX) urging them to not increase taxes on carried interest capital gains. In addition, Congressman Hudson and many other Members of Congress sent a letter to Chairman Brady thanking him for not including a carried interest tax increase in the House GOP’s Better Way Tax Plan released in 2016. The letter strongly urged Chairman Brady to ensure that a carried interest tax increase stays out of any proposal as the actual legislative text is developed. Protecting the appropriate capital gains tax treatment for carried interest will continue to be a focal point of the AIC’s efforts in 2017. Vigorous and thoughtful opposition to this tax increase will be the key to victory on this issue. On maintaining interest deductibility, private equity-backed businesses and most operational businesses that rely on debt financing to sustain and grow their operations are likely facing their greatest tax reform challenge. Unfortunately, interest deductibility is at risk in tax reform primarily because its elimination would score as raising sizable revenue that could be used as a “pay for” for other tax reform priorities (e.g., rate reduction, “100 percent” expensing, etc.). The AIC, working with many other industries, is fighting to maintain interest deductibility. So far, the stiffest challenge to this is the House GOP’s Better Way Tax Plan. That plan calls for eliminating interest deductibility in exchange for allowing “100 percent” expensing on certain capital expenditures. The Trump Administration has expressed concerns about this tradeoff. The Senate has yet to develop its plan on tax reform. It is inventors would find themselves increasingly shut out from investment money available to them from these partnerships. Rather than supporting proposals that lead to higher capital gains tax rates, the incoming Congress and administration should look toward lower rates. One model to follow is contained in the House GOP blueprint, which reduces the top rate on capital gains to 16.5 percent. Today, pro-growth tax reform is needed more than ever. It is imperative that lawmakers prioritize an overhaul of the tax code as well as protect the areas of the current tax code that promote innovation, investment, and growth. Sincerely, Grover Norquist President, Americans for Tax Reform Pete Sepp President, National Taxpayers Union and Foundation Jim Martin Chairman, 60 Plus Association Norm Singleton Vice President for Policy, Campaign for Liberty James Edwards Co-Director, Inventors Project Charles Sauer President, Market Institute Larry Ward Chairman, Constitutional Rights PAC Shaun McCutcheon Chairman, Conservative Action Fund Colonel Rob Maness Chairman, Gator PAC Donny Ferguson Chairman, BetterEconomy.org George Landrith President, Frontiers of Freedom Andrew Langer President, The Institute for Liberty Judson Phillips Founder, Tea Party Nation Paul Morinville Chairman, US Inventors Andrew F. Quinlan President, Center for Freedom and Prosperity Louis Foreman President, Edison Nation Dee Hodges, President Maryland Taxpayers Association David Williams President, Taxpayers Protection Alliance Melissa Ortiz Founder and Principal, Able Americans Dan Weber CEO, Association of Mature American Citizens Mario Lopez President, Hispanic Leadership Fund Gregory T. Angelo President, Log Cabin Republicans Willes K. Lee President, National Federation of Republican Assemblies Derrick Hollie President, Reaching America Phil Kerpen President, American Commitment Dick Patten President, American Business Defense Council Adam Brandon President and CEO, Freedomworks Jeffrey Mazzella President, Center for Individual Freedom Richard A. Viguerie Chairman, Conservative HQ Adrian Pelkus President, San Diego Inventors Forum Randy Landreneau Founder, Independent Inventors of America Iain Murray Vice President, Competitive Enterprise Institute March 9th, 2017 The Honorable Paul D. Ryan Speaker of the House U.S. House of Representatives H-232, The Capitol Washington, D.C. 20515 The Honorable Kevin Brady Chairman, Committee on Ways and Means U.S. House of Representatives 1102 Longworth House Office Building Washington, D.C. 20515 Dear Speaker Ryan & Chairman Brady: On behalf of the undersigned organizations, we write in support of your efforts to pass pro-growth tax reform and urge you to oppose efforts to increase taxes on capital gains. The next four years represents an opportunity to reduce -- not increase taxes on capital gains. Over the past eight years, the top rate increased from 15 percent to 23.8 percent, and the top integrated rate currently sits at 56.3 percent compared to the OECD/BRIC average of 40.3 percent. While it appears unlikely that incoming lawmakers and the administration will increase rates outright, they should also be sure not to incrementally move the needle toward higher capital gains taxes in other ways, like boosting taxes on carried interest capital gains. Carried interest capital gains income is earned through a net gain within a partnership formed between individuals with capital and an expert investor. They are indistinguishable from any other type of capital and so they are paid at the same capital gains tax rates. While supporters of higher taxes on carried interest capital gains say it takes aim at 'hedge fund guys,' it would also hurt pension funds, charities, and colleges that depend on these investment partnerships as part of their savings goals. In addition, small businesses, innovators, and
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  PRIVATE EQUITY RIDESTHE BUSINESS CYCLE | 11NEW LEGISLATIVE AND REGULATORY CHALLENGES AND OPPORTUNITIES FOR PRIVATE EQUITY IN 2017 | 11 extremely important for policy makers in the Administration and in Congress to continually be reminded that eliminating interest deductibility will increase the cost of investments and reduce economic growth over the mid to long term. The likelihood that interest rates will increase in the near future would only exacerbate the damage caused if policy makers decide to eliminate interest deductibility. Pass-through taxation is a third issue of focus for private equity and the AIC in tax reform. The House GOP’s proposal would tax business activity of pass-throughs at a blend of a lower rate (25%), with a new top statutory rate for ordinary income (33%). Regardless of exactly how those rates are blended, this would result in lower tax rates on management fee income and other forms of ordinary income earned by partnerships. The AIC is engaging to make sure that ordinary income earned by PE partnerships is taxed at the lowest rates possible going forward. REGULATORY REFORM— PROGRESS POSSIBLE The Trump Administration and Congressional Republicans have made meaningful deregulation of financial services one of their key priorities. At the same time, Congressional Democrats have made preventing the rollback of the Dodd- Frank Act one of their main objectives. In this environment, while a wholesale repeal of the Dodd-Frank Act is unlikely to succeed, efforts to revise and repeal certain parts of Dodd-Frank will likely be a focus. The Chairman of the House Financial Services Committee, Jeb Hensarling (R-TX), plans to advance his Financial CHOICE Act in the near future, which will be the starting point for legislative efforts to advance regulatory reforms. Although the CHOICE Act is focused on changes to bank regulation, the bill also contains several provisions that would alter the regulatory landscape for private equity. For example, the bill would remove private equity investment advisers from registration with the SEC, repeal the Volcker Rule, and repeal the Financial Stability Oversight Council’s authority to designate non-bank financial companies as Systemically Important Financial Institutions. Even if the CHOICE Act faces long odds in a closely divided Senate, provisions from the CHOICE Act that can achieve bipartisan support could still move forward, including perhaps some appropriate adjustments of the private equity regulatory landscape. Last year, the AIC was successful at advancing the bipartisan Investment Advisers Modernization Act through the House of Representatives. If an opportunity to advance that type of legislation emerges again this year, the AIC is ready to act. Perhaps even more importantly, the changing leadership at the SEC and other regulatory agencies may lead to appropriate lessening of unnecessary bureaucratic burdens on private equity via regulatory changes. In particular, the AIC will remain active at the SEC in advancing sensible reforms to the Investment Advisers Act regime, including ensuring that registration becomes more appropriate for firms of all sizes. Thus, in the regulatory space, while some positive changes are possible in 2017, it is critical to remember that these types of changes will likely be incremental in nature. Some form of regulation of the industry will continue. The question is whether regulations can be more reasonably tailored for the realities of private equity in the United States and abroad. “Last year, the AIC was successful at advancing the bipartisan Investment Advisers Modernization Act through the House of Representatives. If an opportunity to advance that type of legislation emerges again this year, the AIC is ready to act.”
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  In a landscapeof populist politics, broad resentment of “Wall Street,” and a common misunderstanding of where private equity begins and ends, the challenge to communicate the value of our industry may be greater than ever before. Within this challenge lies an opportunity. It is clear that industry misinformation is not going away. We can use this as an excuse, or more constructively, as a call to answer with the positive, accessible case studies that have facilitated private equity’s rapid ascent from cottage industry to major economic force. Such a communications effort, however, must be unified, proactive, and consistent. While PE investments are not always uniform in size or success, and turnaround stories may come with the revelation of necessary, tough decisions, a common thread is shared: These stories should be heard. Establishing our presence is key. There are over 4,000 PE firms in the United States, spread from coast to coast. Collectively they own over 14,000 companies, which in turn employ millions of Americans. Yet, a sense remains that PE is solely a midtown Manhattan operation, far removed from the hundreds of communities that have PE-backed businesses. And, despite an impulse to blame the media or politicians, it may be time the industry looks inward—to our portfolio companies and their employees—to solve this misperception. A commitment to champion portfolio companies over time would highlight an underexposed truth about the industry: PE is a solutions-provider, not a secretive “get-rich-quick” scheme. These stories would share important narratives of growth and revitalization, connecting with the public in a way that macro-level industry statistics simply cannot. Many portfolio companies are rooted in communities that likely know their history; their successes and failures alike. When a PE firm acquires a company they are investing in that company’s future, but those connected to its past— James Maloney Vice President of Public Affairs “A commitment to champion portfolio companies over time would highlight an underexposed truth about the industry: PE is a solutions-provider.” PRIVATE EQUITY IN THE PRESENT DAY 12
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  employees and theconsumers it serves—enjoy the benefits of success along with the firm and its LPs. Just ask the employees of Salt Lake City-based Uinta Brewery, which has seen exceptional growth since it was acquired by The Riverside Company. Or reflect on the rebirth of the nearly extinct Hostess Twinkie, which has been revived since coming under the control of funds managed by Apollo Global Management and Metropoulos & Co. These are the kinds of stories that can shift the narrative around private equity in the media. Why are we confident in this approach? We recently conducted focus groups in various states to test public perception of private equity. As one would expect, most respondents initially confused private equity with other asset classes. However, the exercise was promising. The more a participant was informed about private equity, the more positive their feedback. Further, if a local, successful company was cited as private equity-backed, the attitudinal shift swayed dramatically positive. Our main takeaway? Private equity should be localized, in straightforward terms, and described on a case-by-case basis. We focus on the following questions to make private equity relevant: How does PE impact daily life? How does it make communities more prosperous? Which known companies or brands have been improved by PE? And how does it improve conditions for family, friends, and neighbors? While aggregated investment numbers—such as the $600 billion PE invested in the U.S. economy last year alone—may sound impressive to industry practitioners, we consistently find the best way to articulate private equity’s value proposition is to simplify it and convey local, visible examples. Some PE executives worry that sharing these kinds of stories could bring too much public exposure and therefore isn’t worth the risk—they are content with keeping the “private” in private equity. But the industry has simply grown too large to remain hidden. Now is the time to define the industry on your terms, and add balance to a conversation that often conflates PE with other asset classes, and offers inaccurate undertones of nefarious practices. Integrating good public relations, rooted in real-world, local examples, mitigates the policy and political risk that occurs at the national and, increasingly, state level. There is no time like the present. Some private equity firms are looking to further their smart, active management into retirement-style vehicles, which all but guarantees increased scrutiny. Combine this with our new Administration’s calls for private capital to assist municipalities with a massive infrastructure overhaul, and PE will remain in the public eye. Again, it is up to you to ensure that PE is understood and appreciated for what it is—a long-term, responsible investment class that benefits individuals, local businesses, and the American economy. The story of private equity continues to be written. The next chapter is largely dependent on the industry’s long- term, responsible investments and growth. But, for you—PE practitioners, portfolio company CEOs, and other relevant stakeholders—this chapter also needs another component. Your voice. PRIVATE EQUITY IN THE PRESENT DAY | 13 Twinkies are Back and Better Than Ever Uinta Brewing Taps Riverside Co. to Help Sell Suds Beyond Salt Lake
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  Adams Street Partners ACONInvestments American Securities Apollo Global Management ArcLight Capital Partners Bertram Capital Management The Blackstone Group The Carlyle Group CCMP Capital Advisors Clearlake Capital Group Crestview Partners CVC Capital Partners The Edgewater Funds Genstar Capital GTCR HarbourVest Partners Hellman & Friedman Investcorp International Inc. The Jordan Company Kelso & Company Kohlberg Kravis Roberts & Co. KPS Capital Partners Madison Dearborn Partners New Mountain Capital Pantheon Ventures Providence Equity Partners The Riverside Company Silver Lake Partners Sterling Partners TA Associates Thoma Bravo TPG Capital Vector Capital Versa Capital Management Vestar Capital Partners Welsh, Carson, Anderson & Stowe AIC ASSOCIATE MEMBERS Baker Botts Cleary Gottlieb Steen & Hamilton Davis Polk & Wardwell Debevoise & Plimpton Deloitte EY Greenberg Traurig Hogan Lovells U.S. Kirkland & Ellis KPMG Latham & Watkins Paul, Weiss, Rifkind, Wharton & Garrison PricewaterhouseCoopers Proskauer Ropes & Gray Sidley Austin Simpson Thacher & Bartlett Sullivan & Cromwell Vinson & Elkins AIC MEMBERS MEMBERS 14
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  INTERESTED IN LEARNINGMORE? Contact us: 799 9th Street NW, Suite 200 Washington, DC 20001 (202) 465 7700 info@investmentcouncil.org Visit us at investmentcouncil.org |  Follow us at @AmericaInvests