18 November 2016

What does Trump's election mean for the private equity and venture capital industry?

Last week, the world woke to the news that Donald Trump had scored a stunning upset. Since then, many commentators have tried to understand what this means for the American economy, for immigration (and wall-builders), and for world peace – among other vital topics. But, just as he was the most unpredictable of candidates, Mr Trump is likely to be a very unpredictable President – and it is hard to see what he has in store for the American people and the world at large.

However, it is possible to speculate what might be in store for the private equity and venture capital industry, at least as regards the narrow question of regulation and tax, given the various positions Mr Trump has taken in interviews during the election campaign.

The President-elect has made no secret of his hostility to regulation, as evidenced by this declaration of intent on his website:

Ask all Department heads to submit a list of every wasteful and unnecessary regulation which kills jobs, and which does not improve public safety, and eliminate them. Reform the entire regulatory code to ensure that we keep jobs and wealth in America.

Initiatives to abolish red tape are easy to launch, and usually don't live up to their hype. But Mr Trump has been particularly vocal about the “Dodd-Frank Act” and the regulations that followed it, including the notorious “Volcker Rule”, which prohibits US banks from investing in private equity, venture capital and hedge funds. It is possible that this could be rolled back, allowing banks to invest in the private equity and venture capital funds that they promote or manage. It is also possible that the new administration could deregulate private equity and hedge fund advisers at the federal level, but it is unclear how far he is willing to go in that respect. Speculation on deregulation across the entire financial sector has increased following the news that the chairwoman of the SEC, Mary Jo White, is stepping down, and her replacement is being sought by Paul Atkins, a former commissioner of the SEC known for his deregulatory policies, and hedge fund manager Anthony Scaramucci - who has been quoted as saying that the head of the SEC needs to "end the demonization of Wall Street".

As for fiscal policy, Mr Trump has repeatedly vowed to lower income taxes for individuals and businesses, with the current seven tax brackets for individuals to be collapsed to three, 12%, 25% and 33%, while retaining the existing capital gains rate structure (maximum rate of 20 percent) and lowering the corporate tax rate from 35% to 15%. The creation of a low 10% tax on repatriations would, according to his website, "instantly bring trillions of dollars back into the US economy now parked overseas". He has also promised significant increases in infrastructure spending which could benefit many private equity-backed businesses, even if (when combined with lower taxes) increased federal spending will increase the deficit with an uncertain future macro-economic impact.

An important question for the private equity and venture capital industry, though, is the tax treatment of carried interest, and the President-elect has promised that he will make the often-threatened change to tax carry as ordinary income. In his economic policy statement in Detroit in August, he declared: “We will eliminate the carried interest deduction and other special interest loopholes that have been so good for Wall Street investors, and people like me, but unfair to American workers.

But the Republican Party has historically been hostile to any change in the tax legislation governing carried interest and, in any event, it is unclear whether fund managers would end up paying more taxes, particularly if carried interest is characterised as business income with a 15% tax rate. It is also possible that a future President Trump will roll back the tax regulations that are intended to curb "management fee waivers", a tax-efficient mechanism whereby fund managers use some of the management fee to fund their investment alongside their investors, which would further reduce the overall tax burden on fund managers.

Only time will tell what changes a Donald Trump administration will make, but given the more conciliatory figure that has emerged since his victory, as well as the appointment of a Republican Party insider as his chief of staff, many hope that any changes will be more measured and deliberate than some of his campaign rhetoric.

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