Tuesday: Tax transparency, the myth of the unlevered IRRs

Pushing for country-level reporting standards

Over in public markets aggressive tax planning continues to stir concern among investors. On Friday, a group of institutional investors collectively accounting for more than $1 trillion in assets wrote to the Financial Accounting Standards Board to call for increased transparency in tax reporting by multinational companies. Specifically they call for entities’ activities to be broken down to a country-by-country level (rather than US vs rest of world). The rationale being that investors cannot take an informed view on financial, economic or reputation risk without a full picture of a company’s tax strategy. So what? It’s not a huge leap to imagine investors in private funds raising similar concerns in the future. As we have noted previously, tax efficiency is in some ways the elephant in private equity’s ESG room.

Levered or unlevered?

When it comes to track record presentation, that’s the question. At issue is the use of subscription credit facilities. Fund level borrowing used only to be short term in its nature – to allow nimble deployment of capital and precise capital calls. It is now longer-term: poll data from our CFOs and COOs Forum earlier this year points to loans being left outstanding longer, something we hear a lot anecdotally.

LPs want to know what effect this has on IRR. ILPA recommends that net IRR should be presented both with or without use of the credit facility, as referenced in this video from one of our sponsors Withum. This sensible-seeming suggestion may not be as simple as it seems. “Speed to close and ability to close all cash are becoming more important in this competitive environment. Without a line we would need to call capital in advance and leave cash on the balance sheet,” said Blue Wolf Capital CFO Josh Cherry-Seto. “We would at least a few times call large amounts of capital for investments that do not consummate. It is not such a simple exercise and I don’t think, if calculated honestly, the results would be favorable.” Cherry-Seto was speaking at Private Funds CFO’s fund finance roundtable, which will be published in July.

An exercise that is supposed to be giving investors a clearer picture of “real” investment performance, could be pushing the number more into the realms of fantasy.

While we are on credit lines…­­

… these have proved very useful for Australian firm BGH Capital. The firm held its final close on a A$2.6 billion ($1.8 billion; €1.6 billion) debut fund in May 2018 and deployment has been slow; its first deal will complete later this year. The firm has avoided fee drag so far by using “large credit facilities” to cover all expenses and avoid making any capital calls, a source with knowledge of the matter told sister publication Private Equity International. In fact, the fund could be in the unusual position of making a distribution before its first capital call, having purchased and then sold a stake in a publicly listed business as part of an unsuccessful take-private bid.

ESG data questions

Our own Carmela Mendoza will be at the Private Equity International Responsible Investment Forum Europe 2019 tomorrow and Thursday gathering nuggets about how GPs are dealing with the business of gathering and reporting ESG data. Any questions or ideas? Drop her a note.

Today’s round-up was prepared by Toby Mitchenall.