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Conduct consultations

Eleven days to go – that’s how much time the private equity industry has left to consult with the British government on the proposed increase in the carried interest tax. The British Treasury’s evidence session began at the end of last month and is intended to provide answers to three main questions about the best way to tax carried interest. As a reminder, the Labour government wants to close the so-called “carried interest loophole” and raise £565 million ($732 million; €663 million) annually by taxing carried interest as income.

Among those taking part in the consultations with the government is Michael Graham, partner at law firm DLA Piper. In a recording with us for the next episode of the PEI Spotlight podcast, Graham outlined three key issues for the industry:

• Grandparent protection provisions: whether existing funds will be affected by an increase in tax rates or not. “This would be particularly relevant if, for example, venture capital is needed,” said Graham.
• Simplification of the carry tax: The UK carry tax system is “probably one of the most complex, if not the most complex” in the world, according to Graham, who has called for a single rate. Raising the capital gains tax rate to 33 or 34 per cent while enforcing higher rates on income and dividends means the effective tax rate is almost 40 per cent – which does not seem fair, he argues. “I would hope that it would be politically acceptable for the Labour government to increase the tax rates on carry but introduce a single rate so that there is not a huge loss to carry holders overall.” This could go down well with the wider public, he added.
• Explanation of venture capital: The UK Chancellor’s position on treating carry as a capital gain when fund managers risk their own capital is still unclear. Does a GP’s own commitment to a fund represent a co-investment and therefore equity risk? Or does this relate to the arrangement in regimes such as France, where managers can contribute 1 per cent as a capital commitment to acquire the carry and then benefit from the flat tax rate of 34 per cent?
• Use of GP obligations: Also, if a GP obligation is financed by debt, can this still be considered equity risk? “I would say if you have a loan, but the loan means you as an individual are at risk and the loan is not guaranteed by the sponsor, then it would make sense to consider equity risk. But we really need to look at this in detail,” Graham said.

Stay tuned for the episode next week.

Consolidation: inevitable?

The general view is that the private equity industry will continue to consolidate into a smaller number of larger firms. Partners Group CEO David Layton, for example, predicted last year that the number of active players in the private equity industry could fall from around 11,000 to fewer than 100 over the next decade. Higher interest rates, financing difficulties and rising regulatory costs would bring about a “new phase of maturation and consolidation,” he said.

However, not every company will succumb to this trend. John Kelleher, Senior Partner at McKinsey, says Side letter that while consolidation will be driven in part by LPs’ desire to deal with fewer counterparties, the market will not necessarily revolve around the fund giants we see today. “I think there will be a lot of specialty funds,” says Kelleher, noting that those that can generate “sustainable and long-term returns” will have plenty of room to grow while some consolidation continues.

According to a study published in May by investment advisory firm Callan, sector specialist funds are now outperforming multi-sector funds in terms of the number of funds launched. Sector specialists are particularly common in venture capital and growth equity, where funds focused on technology are particularly popular.

“The increased need for technical understanding within each sector among GPs has opened up opportunities for emerging and minority managers to differentiate themselves from more established managers through their specific expertise and experience in an area that larger/more established firms have not previously penetrated,” wrote Chrissy Mehnert, assistant vice president of Callan’s Alternatives Consulting Group, in the study.

Of course, it is not uncommon for PE giants to buy up specialist firms or teams that would prove difficult to grow organically (a typical example is EQT’s acquisition of Dutch life sciences venture firm Life Sciences Partners in 2022). So while some specialists may well find room to grow as other firms consolidate, they will not be entirely excluded from this trend.

Basic equipment

HarbourVests Yield

HarbourVest Partners has raised the third largest secondary fund in history. The investment giant closed Dover Street XI at $15.1 billion, which is above the $12 billion target and almost double the size of its predecessor. Our colleagues from Secondary investor Details can be found here (registration required). Fund XI is the largest secondary market vehicle raised this year and the third largest ever, behind Lexington Capital Partners X – which closed at $22.7 billion last year – and Blackstone Strategic Partners’ $22.2 billion Fund IX in January 2023.

The closing of Dover Street XI coincided with that of HarbourVest’s co-investment vehicle Secondary Overflow Fund V, which raised $3.38 billion, exceeding its $2 billion target. Fund XI received commitments from entities including Arkansas Public Employees Retirement System, Connecticut Retirement Plans and Trust Funds, Fubon Life Insurance, Nebraska Investment Council, National Pension Service of Korea and State of Michigan Retirement Systems. PEI Show data.

More and more investors want to support secondary funds as LPs continue to use the market despite a lack of distributions and overallocations in the private markets, according to Private Equity International‘S LP Perspectives 2024 StudyIn the first six months of this year, a total of 34.5 billion dollars were raised through the final closures of 44 funds, according to Secondary investor Data. The first half of 2023 ended with $40.5 billion, but this was driven by Strategic Partners Fund IX, which accounted for about 54 percent of total fundraising.

Dig deeper

LP meeting. It’s Monday, so here are some LP meetings to watch out for this week.

19 August

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21 August

22.08.

23.August