Private Equity Gets Its Own Bailout

Last month, Senator John Ensign (R-NV) introduced legislation that would have provided a temporary suspension of income taxes for companies buying back their own distressed debt. The plan did not make it into the Senate’s economic stimulus package, but Ensign nonetheless managed to get a compromise that would amount to a massive bailout for private equity-backed companies.

For the uninitiated, companies are required to pay income tax on any “gains” made by buying back their own debt at reduced prices. For example, imagine that Wire Corp. negotiates with its lenders to buy back $1 billion worth of notes for $700 million. Wire Corp. would then be required to pay income tax on the $300 million difference. The original Ensign bill would have eliminated those taxes for 2009 and 2010, but the compromise would defer 2009 and 2010 payments until 2011 (at the earliest), and then allow them to be paid out over an eight-year period.

The U.S. Chamber of Commerce has been a chief proponent of both the original Ensign language and the compromise plan. As Chamber lobbyist Bruce Josten explains: “Giving temporary relief from income tax related to the cancellation of debt will fulfill the exact same purpose originally envisioned for the TARP program… It’s identical to what’s being provided for home mortgage holders, except that it only uses private sector money.”

Dean Zerbe, a former counsel to the Senate Finance Committee, also was supportive, but a bit more circumspect: “I think Ensign should be commended for finding a good middle ground that certainly will get through the Senate… But clearly this is something that will be more helpful to private equity-backed and big companies, than to the small and mid-sized companies I work with. They’re having a hard time getting banks to even return their calls, let alone negotiate debt buybacks.”

Finally, there was this line from the source who first alerted me to the language: “This is a lifeline for private equity firms that are over-levered… If these are good companies making good products, why shouldn’t they just go through the bankruptcy process? It may wipe out the private equity firm’s investment, but isn’t that part of the risk you take when you pile debt onto a company?”

For my part, I somehow agree with each of the above comments – perhaps reflecting my larger ambivalence toward bailouts. After much thought, however, I see this language as doing more good than harm. Yes, it’s a giant giveaway to the private equity firms, particularly given that they don’t plan to own these companies once the final tax bill comes due. But there is inherent value to corporate solvency, particularly until DIP financing returns en masse. People keep jobs, companies can make more capital expenditures, etc. If certain PE pros happen to get a mulligan for dumb deals, well then it’s a bitter pill worth swallowing.

That said, this bill also needs an addendum: Companies taking advantage of the tax deferrals should be required to pay interest on the deferred payments. It’s one thing for the government to lend a helping hand to companies in need, but quite another to subsidize their initiate mistakes. Hopefully the Senate heeds that call, although opposition from the Chamber of Commerce likely means it won’t.

Here is a copy of the Senate’s bill. The relevant language begins on page 74.