The revamped tax code will be a boon to private equity portfolio companies, a study by the PitchBook research group finds.
Slicing the corporate tax rate to 21% from 35% will boost free cash flow and also PE-owned companies’ enterprise value (EV), which is the market value of common and preferred stock and debt, minus cash and investments.
That in turn should increase EV/EBITDA (earnings before interest, taxes, depreciation, and amortization) multiples, PitchBook says.
But the new tax law also will keep debt in check, according to the research firm: PE outfits will limit leverage to no more than six or seven times EBITDA. That’s because interest deductibility is now capped at 30% of EBITDA.
Still, an upside is that the Tax Cuts and Jobs Act encourages more buyouts, since asset purchases now can be expensed immediately on tax forms, as opposed to written off gradually over a number of years. This new feature of the tax code, PitchBook writes, gives “companies an immediate tax savings for investing themselves.”
By the same token, PitchBook warns that fewer exits from buyouts will occur in less than three years. Reason: That’s how long, under the new statute, that PE operators must keep a portfolio company to realize favorable long-term capital gains taxes on carried interest, the share of the profits from divesting a PE asset.