PE & The Coronavirus Stimulus: Challenges and Opportunities
Managing a company in the midst of the coronavirus pandemic is a challenge of enormous complexity, one that requires not only a deft operational response but a ready command of the multiple support programs enacted by the federal government, including the Federal Reserve.
While the fine print of those programs makes the challenge even greater for private equity fund managers, says Theresa Urband, a partner at RSM US LLP specializing in federal business tax, there are still many provisions that will benefit PE firms looking to shore up cash flow and balance sheets as the pandemic grinds on.
The Federal Response
To date, the federal CARES Act legislation passed by Congress and the Main Street Lending Program launched by the Federal Reserve are the two primary vehicles for supporting small and medium-sized businesses owned by private equity.
The CARES Act
Enacted on March 27, the CARES Act provides approximately $2 trillion in relief for businesses and individuals.
The tax provisions of the Act with the most likely benefits for private equity include:
- Delayed payroll tax payments: Unless taking advantage of the PPP, companies can delay making their portion of Social Security payroll tax payments, with 50% due on Dec. 31, 2021 and the remainder due on Dec, 31, 2022. The payroll tax rate is 6.2%, so the provision not only increases short-term cash flow, but the money effectively earns companies a 6.2% return through the repayment period.
- Credit against employment taxes equal to 50% of qualified wages, not to exceed $10,000 (or $5,000 max credit per employee): While there are limitations for companies with over 100 employees, nearly all companies should be able to meet the “eligible employers” test and demonstrate economic hardship to qualify for this credit for payroll costs related to employees retained.
- Net operating loss (NOL) “carryback”: The Act rescinded provisions from the 2017 Tax Cuts & Jobs Act (TCJA) that placed restrictions on the use of NOLs for tax purposes. Firms can now “carry back” losses generated in 2018, 2019 and 2020 tax years for five tax periods to free up cash from taxes paid in prior years.
- Suspended business loss limitations: The excess business loss limitations introduced with TCJA have been retroactively deferred until 2021. This means that fund investors may able to use the losses from flow-through investments for immediate tax savings and refund opportunities.
- Retail glitch “fix” for QIP: The ACT corrected a “glitch” in the TCJA provisions that excluded qualified improvement property from bonus depreciation. Companies can retroactively take 100% bonus depreciation for 2018 and subsequent years, potentially increasing NOLs carryback claims.
- Modified Interest Limitation: The ACT increased the ability to deduct interest payments from an amount equal to 30% of Adjusted Taxable Income (ATI) to an amount equal to 50% percent. More importantly, allows taxpayers to utilize 2019 ATI in determining the 2020 limitation, which will yield a greater deduction for leveraged companies.
Unfortunately, the Act’s flagship program for businesses, the Paycheck Protection Program (PPP), which applies to companies with fewer than 500 employees or can meet the other alternative size standards set forth by the SBA, is out of reach for many private equity firms. That’s because the 500-employee threshold applies for the PE firm’s entire portfolio under the affiliation rules, rather than on a company-by-company basis.
The Main Street Lending Program
On April 9, the Federal Reserve announced its Main Street Lending Program to expand support for mid-sized businesses that aren’t eligible for the Paycheck Protection Program. Unlike the PPP that allows for debt forgiveness on costs incurred for payroll costs, the Main Street Lending program is not forgivable, but it does offer 4-year loans at adjustable interest rates of Secured Overnight Financial Rate (SOFR) plus 250-300 basis points, ranging from $1 million to $24 million, with principal and interest payments deferred for one year. The Main Street Expanded Loan facility may allow loans up to $150 million.
While some of the terms have yet to be worked out, Urband anticipates that more private equity firms will be able to qualify for these loans given that U.S. companies with up to 10,000 employees or $2.5 billion in 2019 annual revenues may qualify. The amount of debt that can be borrowed under the Main Street New Loan Facility and the Main Street Expanded Loan Facility are subject to EBITDA limitations when combined with existing debt. These limitations may pose obvious problems for an industry, like PE, that relies heavily on leverage to boost returns.
Urband says PE will need to carefully weigh the restrictions associated with the loans before committing, i.e. paying dividends or distributions to investors and owners during the duration of the loan and for 12 months following. Lastly, Urband noted that management should be aware that debt restructurings could have unintended tax consequences, such as cancellation of debt income.
The Bottom Line
While the current stimulus programs may not be the most favorable to private equity-backed investments, PE and investors are hopeful that future packages will provide an opportunity to address some of the current PE-specific shortcomings.
Until then, Urband said, fund managers and their advisors should be picking apart the existing programs to extract maximum value.
Tune in to RSM’s COVID -19 response Webinar dedicated to tax issues for private equity firms and their portfolio companies on Wednesday, April 15, at 4 p.m. EDT. Click here to receive a calendar invite with the logistical details for the webcast. Click here to register.