ECI tax holds up secondaries deals – report

Tax changes introduced by the US administration are holding up secondaries transactions, according to a report by Elm Capital.

Holding tax on effectively connected income has considerably increased the time taken to execute deals this year, the London-based intermediary wrote in its Private Equity Secondaries Review H1 2018. ECI means from 1 January non-US sellers of stakes in limited partnerships that have exposure to a US trade or business – even as little as $1 – can be subject to a 10 percent tax on their realisation.

“The implication is that before closing a transaction, sellers need to confirm with each GP whether any of their portfolio company has ECI,” the report noted. As this is not a priority for many managers, obtaining confirmations from every single GP in the portfolio takes time. In some deals parties will agree to deal with the ECI issue between signing and closing, whereas in others the parties prefer to settle this before signing the sale and purchase agreement. This can add “considerable delay” to signing, Elm noted.

Elm found the median transaction time from signing the mandate to closing is 30 weeks. This is split between 12 weeks from signing the mandate to selecting the buyer through a two-step auction, and 18 weeks to negotiate the SPA and organise all the transfers.

The timing required to close a transaction can vary greatly depending on the number of funds, the time required by the seller to make decisions, the complexity of the SPA negotiation and the co-operation of the GPs, the report noted.

Elm also found that the median price achieved for a buyout fund was 99 percent of net asset value in the first half of the year. Leverage has become more commonplace in the secondaries market, meaning the most competitive bidders in auction processes are either those with a credit facility in place or those willing to accept a lower return target.

Buyout funds garnered the most attractive bids in the first half, with 61 percent of all offers made at par or above.

Heightened stock market volatility and lengthy transaction times could increase the use of material adverse change clauses in binding offers and purchase agreements in the second half of the year, the report noted. Such terms enable buyers to back out or alter deal conditions in the event of a substantial change in the condition of the business.

Managers forecasting a correction in the markets are expected to look to crystallise their returns in the second half, while limited partners may be more prone to sitting on the side lines as a favourable exit market drives healthy distributions and excess liquidity, Elm wrote.