This Agreement is Binding… Until November-ish

The House Ways and Means Committee yesterday approved an alternative minimum tax relief bill. This could affect PE pros because, if the AMT tax is done away with, Democratic lawmakers need a way to replace the $61.5 billion it collects from middle to upper-middle class individuals. One plan for replacement is through a change in carried interest tax treatment (such as considering it ordinary income, instead of capital gains).

So, another step toward raising taxes on private equity profits. Temper that with the assumption that carried interest tax law will change no matter which candidate is elected in 2008. (Private Equity Council’s Doug Lowenstein said this in April.)

This development reminded me of some LP comments at last week’s PE Networking Event in Chicago. One LP mentioned that most LPAs he sees today have some form of a “just in case” clause addressing potential changes. Buyouts addressed this last year, but at that point it was too early to tell how many and how binding the clauses were. Checking back in with a few LPs, I found the following:

  • Most GPs admit the days of tax-free carried interest are over. They’ll fight it till the end of course. Unless you’re in same camp as InterMedia Partners’s Leo J. Hindery. (His black sheep testimony in favor of carried interest tax puts some of his peers to shame. Read it here.)
  • Therefore, most fundraising lawyers include some type of provision to acknowledge likely change and protect the carried interest of their clients.
  • Most provisions are watered down, non-binding and vague. They often require GPs and LPs to come to a mutually satisfactory solution in the event of a tax change. Makes sense, given we don’t know exactly what the change will be (though many assume carried interest’ll just be taxed the 35% like regular income). LPs thus far, have no problem with this, but as one said, “We tell them, ‘Lets talk about it at the time.’”
  • The LPs I talked to don’t particularly like the idea of raising fees as a way to make up the difference. Naturally, they’d rather back GPs with more skin in the game. Still, they’re more likely to agree to less attractive terms for a fund of a firm in high demand.

Now I wonder—for firms planning to come to market toward the end of this year, will they wait? How long could it take for such a law to be passed and implemented?