France’s LBO Firms See Death From Hollande’s 75% Carry Tax
French private-equity fund managers are predicting their own exile if lawmakers back President Francois Hollande’s proposed tax increases on the profit the industry makes from investments.
Hollande, who released his first annual budget on Sept. 28, plans to tax fund managers’ share of the profit from their investments, known as carried interest, at a rate of as much as 75 percent, part of a wider effort to increase taxes on the wealthy and narrow the country’s deficit. France also plans to as much as double taxes on capital gains and restrict the amount of debt interest payments a company can deduct from its taxable income, a measure that will reduce returns on leveraged buyouts.
Lower levies in the U.K. will lure professionals across the English Channel from where they can still try to buy French companies, Parisian dealmakers say. More than 280 private-equity firms call Paris home, including Astorg Partners, Wendel, LBO France and PAI Partners, which plans to start raising a 3 billion-euro ($3.9 billion) fund this year. It’s also Europe’s second-largest market for leveraged buyouts after Britain.
“We understand we need to contribute to the nation’s efforts, but if all these proposals are actually implemented, it means the death of private equity in France,” Gonzague de Blignieres, a Paris-based partner at Equistone Partners Europe Ltd., said in an interview. “There won’t be a buyout fund management company left in Paris.”
Equistone, based in London, was spun off from Barclays Plc last year. While the firm has no intention to leave France, the tax measures have prompted internal debate on whether to review a move of some Parisian staff to the British capital, where carried interest is taxed at 20 percent to 30 percent, Blignieres said. Equistone employs 14 people in Paris, including Managing Partner Guillaume Jacqueau, according to its website.
The French private-equity industry and its 3,000 executives are following a protest started by entrepreneurs who have dubbed themselves “pigeons,” roughly equivalent to “suckers” in French slang. Hollande announced 20 billion euros in tax increases, including a levy of 75 percent on incomes of more than 1 million euros, as the government seeks to cut the deficit to 3 percent of gross domestic product from 4.5 percent estimated for this year.
The budget, which also includes a new tax rate of 45 percent on incomes of more than 150,000 euros, has yet to be approved by parliament.
‘Door is Open’
“We’re not exactly popular these days, so the measures will probably be implemented,” said Marc-Olivier Laurent, a partner at Rothschild in charge of the bank’s private-equity funds. “Private-equity people will move elsewhere to do their deals, but that’s not the biggest issue. What’s really worrying is the impact on entrepreneurs, their desire to create and sell companies.”
French entrepreneurs’ lobbying prompted Finance Minister Pierre Moscovici to say this morning that he’s open to amending the increase in capital-gains tax.
“If the measures discourage investment, then we will make changes,” Moscovici said in an interview today on France Inter radio. “My door is open.” He didn’t refer to the taxation plan on carried interest.
Although countries such as the U.S., U.K. and Sweden have sought to levy higher taxes on LBO executives to help plug their deficits, Hollande’s measures would make the French private- equity industry the most taxed in the world, according to Christian Nouel, a Paris-based lawyer at Morgan, Lewis & Bockius MNP.
Typically, fund managers receive 20 percent of a fund’s profit from their investors when all the assets have been sold above a minimum annual return, known as the hurdle. French LBO fund managers today pay the state about 35 percent on carried interest, which is traditionally the largest part of their compensation. Partners are also taxed on gains made on the personal money they place alongside their investors, usually 1 or 2 percent of the fund’s total.
Hollande is seeking to treat carried interest as income, which means that it would be subject to social-security taxes, and amounts of more than 1 million euros would be taxed at the 75 percent “exceptional” rate for two years.
The tax proposal “is an aberration that will demoralize those who take an entrepreneurial risk on a daily basis to help companies expand, and who kept injecting fresh capital even during the crisis,” Association Francaise des Investisseurs pour la Croissance, or AFIC, which represents private-equity firms, said in a Sept. 30 press release. The industry will “collapse in France if those measures are enacted,” AFIC Chairman Louis Godron said.
France isn’t the only country debating how private-equity executives should be taxed. U.S. presidential contenders Mitt Romney and Barack Obama have pledged to pursue changes to the country’s tax code, which is likely to include a reconsideration of carried interest and capital gains. In 2010, the U.K.’s coalition government lifted capital-gains tax to as high as 28 percent from 18 percent.
French buyout executives say Hollande’s proposal to raise capital-gains levies will crimp transactions as entrepreneurs refrain from selling their companies. Under the government’s proposals, French business owners may have to give more than 60 percent of their gains to the state if they sell.
“This is already affecting the volume of private-equity deals,” Nouel said. “There’s no seller. Why would an entrepreneur sell now? This is problematic for private equity- backed companies that counted on acquiring smaller firms to expand and make their returns.”
Private-equity firms have either sold or bought companies valued at $2.9 billion in France so far this year, down from $30 billion in the same period last year, according to data compiled by Bloomberg. That’s the least since 2009, the nadir of the credit crisis, and is less than one-tenth of the $35.5 billion of transactions in the U.K.
The measures also risk hampering private-equity fundraising, according to AFIC. French firms have amassed 1.8 billion euros in the first half of this year, or 28 percent of what was raised in all of 2011, due to the combination of more stringent banking capital requirements and a deteriorating economy, according to AFIC’s Godron, who is also managing director at private-equity firm Argos Soditic SAS.
“We don’t see what would enable us to reach the 2011 levels,” he said during an Oct. 3 press conference in Paris.
Among other measures, Hollande wants to limit the amount of interest a company can deduct from its taxable income to 85 percent of the total in 2012 and 2013, and 75 percent thereafter. That would penalize companies that took on debt to grow and are struggling in the crisis, Godron said.
Faced with mounting outrage from entrepreneurs, the government today said it would try to soften the taxation of capital gains further when the proceeds of a sale are reinvested.
“We’re going to make adjustments so that there won’t be something very penalizing for company creation and innovation,” Fleur Pellerin, deputy minister for small business, said today on RMC radio.
The private-equity industry may be over-reacting by asserting that the issue of carried interest will be lethal, said Jean Peyrelevade, chairman of Leonardo Midcap CF. He managed President Francois Mitterrand’s nationalizations of companies in 1982 as deputy chief of staff for Prime Minister Pierre Mauroy.
“Those who got accustomed to the type of compensation they used to get might move, but as long as there will be deals and money to be made, the private-equity industry will reconstruct itself with new people,” Peyrelevade, who advises on mergers and acquisitions, said in an interview. “It’s a very local business. Executives based in France will always have a competitive edge compared with those flying in from London.”
The issue beyond private equity is that young entrepreneurs may want to start their ventures elsewhere, Peyrelevade said.
“The most durable and damaging effect is the threat on what’s left of the entrepreneurial spirit in France,” Jeremie Le Febvre, founder of private-equity consultant TBG Advisors, said. “Ultimately, percentages are secondary as taxing 60 percent or 75 percent of zero will always be zero.”
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