How the U.S. Election Could Impact the Private Equity Sector

With the U.S. presidential election upon us, financial markets are still perplexed with the mixed exits poll outcome as both the Democratic nominee, Vice President Kamala Harris, and the Republican nominee, former U.S. President Donald Trump, appear to be neck and neck in the polls. Private equity investors have been waiting on the sidelines with their highly illiquid investments, and they are watching closely at  possible marketplace volatility once results are announced. Typically, when there is an unexpected major political development, there is volatility in the marketplace. 

Regardless of who wins, there are a few topics about which private equity investors are most concerned:  

Taxes on Carried Interest and Unrealized Gain 

Both parties have provided details of their fiscal and economic agendas, some of which impact the private equity world. Under Harris’ tax proposals, carried interest and distributions received from carried interest will be treated as ordinary income (not just those held for less than three years), as opposed to a capital gains tax. Even if the provision to treat all proceeds from carried interest as ordinary income is not passed, another Democratic proposal is to tax all long-term capital gains as ordinary income for taxpayers with incomes of more than $1 million. Secondly, Harris plans to tax long-term capital gains and qualified dividends at ordinary income tax rates for taxable incomes above $1 million. 

Additionally, among the list of tax proposals to achieve higher collections, Harris, in August 2024, endorsed the tax increases proposed by President Joe Biden in his fiscal year 2025 budget. According to CNBC, one of the proposals is a 25% minimum tax on total income, including so-called “unrealized gains,” or asset growth, exceeding $100 million. If that provision is enacted, taxpayers with wealth greater than the $100 million threshold would have to report unrealized gains for each asset class annually, including the basis, or original purchase price, and market value as of December 31. They would also report total liabilities. However, the plan has failed to gain broad Congressional support. 

Trump has not proposed any changes to current law, which requires a holding period of more than three years. The Republican Party is advocating a reduction in the top capital gain tax rate from 20% to 15%. They have also proposed eliminating the net investment income tax (“NIIT”), which would effectively reduce the current rate by 3.8%. 

Valuation Swings  

The election receives considerable attention from both local and global markets as politics can greatly impact the private equity industry. Biden’s exit from the presidential nomination resulted in a healthy bull run during Q2 and Q3 2024, despite geopolitical upheaval in the Middle East.  

Private equity and venture capital managers who utilize the market approach for valuation of their private investments may observe considerable fluctuations in the multiples and market caps of comparable companies, since the election is close to year-end. Sector-specific spurts in the market are expected, which will require scrutiny before valuation.  

Hope of Stability After an Eventful Year 

The current year has seen many events across the globe that have impacted private equity investors. With China’s economy slowing down and the Japanese market hitting an all-time high, fund managers have reshuffled many of their capital allocations. Crude oil, which touched a low of $65 in September 2024, inflated due to Middle East conflict.  

On a positive note, the private equity sector, including their portfolio companies, benefited from a reduction in interest rates by the Federal Reserve in Q3 2024. This fostered cheaper debt and improved cash flows, which may lead to increases in valuations and higher earnings multiples. Investors have appeared willing to pay more for companies with strong cash flows and lower financing costs, resulting in more lucrative exits for private equity firms. 

Once either party achieves congressional majority post-election, coupled with reduced interest rates and a conducive geopolitical environment, private equity transactions should rise with ample available dry powder.  

This article is for information purpose and does not advocate any political party, ideas, or position.