Riverside Co defends carried interest as a tax code staple

  • Execs at firm say path forward is unknown
  • Riverside Co nevertheless is picking up its pace of deals
  • Basic tax law groups carried interest under capital gains umbrella

While officials at Riverside Co said the regulatory and tax landscape remains uncharted under President-elect Donald Trump, they argued that carried interest should continue to be taxed as a capital gain rather than income.

Both Trump and Democratic rival Hillary Clinton both supported a switch to treating carried interest as income, but it remains to be seen how tax changes will filter through the newly elected Congress.

Béla Szigethy, co-CEO of Riverside, couched the challenges facing private equity in the form of a question from the TV game show Jeopardy. The answer is “it’s unknown” and the question is, what’ll happen under President Trump after he is inaugurated in January, he said at a Nov. 17 breakfast with reporters in New York.

Stewart Kohl, co-CEO, said the tax code already classifies carried interest as capital gains, so it’s not a loophole for avoiding income tax.

“This has really been tax policy since 1933,” Kohl said. “It’s not a loophole because this is the way the IRS has treated carried interest. We don’t get letters from the IRS questioning our treatment of it.”

Unlike entities such as Berkshire Hathaway that never sell their companies, PE firms generate taxes by buying and selling their portfolios, he said.

If the carried-interest tax goes into effect, Kohl said, some PE professionals could possibly end up looking elsewhere for work or modifying their investment behavior slightly.

“It won’t rock the industry,” he said.

COO Pam Hendrickson, who focuses on government policy along with her other work at the firm, said a big tax overhaul is unlikely to come right away, given that any major changes will require 60 votes in the U.S. Senate. It’s more likely that incremental changes may come as add-ons to bills that must pass, such as the massive omnibus spending bill that keeps the federal government running.

Meanwhile, regulatory pressure on the industry may ease a bit, an idea that’s gained traction inside the Beltway since the election, she said.

Earlier this week, Mary Jo White, the chairwoman of the Securities and Exchange Commission, will step down in January. Riverside Co executives echoed sentiments by other private equity firms about the SEC’s efforts to regulate the industry through enforcement actions rather than rule-making. They hope this practice eases once White departs.

For its part, Riverside continues to bear down on deal-making in the lower middle market regardless of what happens in Washington, Szigethy said. The firm hopes to quicken its pace to 60 to 65 deals in 2017, with a focus on a wide array of acquisitions and exits in consumer, healthcare, specialty manufacturing and distribution, software-as-a-service and other verticals where it can leverage its expertise, he said.

In 2016, the firm expects to handle 34 add-on deals and 18 platform deals for a total of 52, up from 28 add-ons and 15 platform deals for a total of 43 in 2015. In 2016, the firm also made six debt or minority investments, compared with just one in 2015.

The firm has been playing up its emphasis on credit investments and add-on deals to put money to work despite high prices.

In 2014, it raised its first Strategic Capital Fund to provide credit and equity for company owners who want to retain control of their businesses. It’s also launched the Riverside Acceleration Capital Fund to lend to software-as-a-service companies. It’s also investing in senior debt via its Riverside Credit Solutions Fund.

“The demand for credit exceeds supply,” Szigethy said.

David Toll contributed to this report.

Action Item: Riverside Co: www.riversidecompany.com

Stewart Kohl and Béla Szigethy, co-CEOs of Riverside Co. Photo courtesy of the firm.