How to raise European capital in a post-Brexit world

This article is sponsored by EisnerAmper.

What are some of the top line trends influencing private equity fund structures today?

Much of the thinking around how fund structures are changing relates to shifting investor preferences and the tax changes we have seen over the last few years, such as the lowering of corporate tax rates and small changes to the taxation of carried interest.

So are structures changing?

The way that private equity firms set up funds is much more configured than it might have been a few years back, but they tend to use the same structures as in the past. BEPS [Base Erosion and Profit Shifting] in very simple terms was really all about ensuring that companies can’t use low tax jurisdictions to avoid tax in the jurisdiction they were supposed to be paying it in. It made it much more difficult for people to set up spurious holding companies. You need to look at substance and whether you are paying in your home country at a rate the local authorities will be happy with.

With private equity fund structuring being about tax efficiency for managers and investors, BEPS has been very significant in making it much more difficult to structure and hold investments globally. Firms generally continue to use the same structures as in the past, but have to be much more careful about where they are holding the portfolio companies.

US tax reform has now been in place for a year-and-a-half; has any of it affected fund structures?

There is a now a consideration as to whether a partnership is the appropriate structure for a private equity fund, given the corporate tax rate is now 21 percent; it has made corporations a lot more palatable as a fund structure. All of that said, there are commercial considerations at play. Is it what investors are going to accept? What is going to sell? While there may be efficiencies in making some of those changes to structures – although even these are not 100 percent clear cut – investors might not feel comfortable with it. So there hasn’t been a wholesale shift to a different fund structure.

We have seen the large listed firms converting from publicly traded partnerships to corporations, primarily with a view to attract new types of public shareholder. Is this also a consideration for smaller privately held firms?

In terms of setting up the fund itself, it goes back to the commercial consideration of it. It is certainly an option, but so far firms are opting to give investors what they are used to. Likewise, for the general partner itself, there has been no move to switch from partnership to corporation.

What about tax on carried interest? Has the requirement to hold assets for at least three years in order to qualify for the lower rate of tax changed PE firms’ behavior at all?

No, because it has moved to three years and realistically holding periods are rarely shorter than that. Trump has once again said that carried interest needs to be looked at, but he has been saying that for a while and I am not sure we are going to see a change again. The move to three years under the tax act was not a bad answer for PE.

With the Brexit deadline looming in October, how would a US firm raising capital in Europe do it today?

I think the way that you approach the market from a capital raising perspective is very different, given Brexit, than before.

When you look at where you are going to raise money in Europe, depending on the rules around equivalency, you may – may – need to change your approach totally. The office in London may need to have a twin sitting in Paris, Berlin or Dublin.

On the investment side, it has to be a challenge to look at Europe and the UK; I think it probably presents opportunity but a lot of what we are seeing is clients taking a wait-and-see approach. At this point – given we are waiting for that October deadline – fund managers and investors are waiting until they have more clarity.

What about the technical aspects of raising capital from European investors?

There are a number of different models for raising money in Europe. There are “tied agent” models in which you in essence become tied to an outsourcer with regulatory authority in Europe outside of the UK: that allows you to raise money ex UK. The alternative is that you need to set up your own fully regulated operation in Europe, which we are seeing happen in Dublin and Luxembourg particularly.

Otherwise many of the US fund managers have historically had UK-based asset raising arms which have allowed them to access European markets. Right now it is uncertain whether this will be a possible option post-Brexit. Looking at other models, such as a tied agent, may be the way forward, but even that isn’t 100 percent certain.

In terms of US managers raising capital in the UK, I would expect the well-trodden path of the private placement regime to continue. But GPs will probably need two separate models: one for the UK and one for the EU. Unless certain equivalencies are granted – which are currently up for debate – a UK entity may not be enough.

Which way is the wind blowing?

In July, the European Commission – in what could be viewed as a first salvo to the UK – removed the equivalence of a number of jurisdictions around the world for credit rating activity. If the commission continues to remove equivalencies, it could make it very difficult for the UK, which would have to go through an entirely new process.

I still believe there is only so much that the commission will be willing to do to the UK, because if the UK goes, then so too does the US. If the EU tells the UK its regulatory permissions are not going to be accepted as equivalent, then the implication would be the same for the US, and I’m not sure the commission wants to disrupt the market to that degree. Continued access to the US is significant.

The bottom line is: you need to really consider post-Brexit how you are going to access capital in Europe.

Robert Mirsky is head of EisnerAmper’s London office and head of the firm’s asset management group.