obamaI don’t know about you, but win, lose, or draw, I am happy to have the recent election behind us.  It’s not so much that I wake up every morning with a sense of great anticipation over a Barack Obama presidency (I voted for the man for the record), but rather I’m ready to get back to business.  Imagine how much productivity was lost to water cooler conversation and the like over this election.  As part of getting back to the task at hand — getting this country back on track —  I thought it might be worthwhile to consider what an Obama regime might mean to the transaction environment and the economy for the next 4 – 8 years.  I think we can parse these in to what we know, what we think and what I hope.

Economy

One of the big selling points for Obama during this election cycle, was his command of economic issues, especially relative to the opposition.  During his stump speeches, Obama pointed the finger at Bush era policies (Rush Limbaugh’s opinion notwithstanding) for having caused the current financial maelstrom — erosion of consumer protections, lack of regulation and misaligned incentives.   So I take it, the president elect is not a fan of the Gramm-Leach-Bliley Financial Services Modernization Act.  To an extent, I believe Obama’s appeal on this issue was not that he was so economically facile, but that McCain was all thumbs when it came to the economy.

That notwithstanding, what can we expect from the new regime?

What We Know: What is clear is that there will be a return to government intervention in business.  Democrats, as a rule, tend not to believe in efficient market theorem. How and in what form(s), we don’t quite know, but this you can take to the bank.  We should expect large investments in modernizing industries to make them environmentally friendly.  We should expect a green “boom” as well as  large investments in core domestic industries that provide jobs to the middle class — manufacturing, automotive and health care.  You can also call it money good in Vegas that Obama will reduce taxes on small business, and small business investment.  This is a sensible approach as small to medium sized businesses provide for a significant portion of the job and tax base in our economy.  Providing these companies more operating runway, absent directly lending to them, should be good for the economy.

What We Believe: One of Obama’s fundamental campaign pillars was tax breaks for the middle class offset through taxes of the uber wealthy.  After all taxes are patriotic.  However, what we don’t know is where the break points will be.  We’ve heard $200,000 in income, $250,000, $275,000, etc., etc.  Tax breaks for the middle class should stimulate spending, given our anemic savings rate.  We should also expect Obama to take unprecedented steps to stimulate the economy outside of the tax code.  However, unlike the Bush administration, we don’t think he will put that money directly into the hands of consumers so they can go spend it at Wal Mart.  Rather, Obama will favor funding programs that provide people relief by offsetting contractions in benefits and services that states might otherwise engage in as part of balanced budget initiatives.

What I Hope:  My most sincere hope is that Obama finds ways to pay for all of this intended intervention and stimulus.  Taxing the wealthy is certainly a lucrative proposition, but uncollected taxes (estimates range up to $300 billion) dwarf, the amount that could be created by taxing excess income, at least based on the numbers I have seen.  Further, people will find ways to offset income in order to avoid tax thresholds.  After all that is the American way.  Ultimately, to bring long term stability to the U.S. economy, Obama’s policies must do more to restore our balance of trade, bring the federal deficit under control and stem inflation.  Easy to say, hard to do.  Much of the campaign promises we have seen from both sides were attempts to capture the voting preferences from niche demographics.  If we had to pay for all those programs, it would likely bankrupt America, twice.  Net net, we need to cut spending and increase our tax base.  This will cause pain, but it is a necessity to getting back to a normalized economy.  Everyone is looking for a pain free path to normalcy, which is not going to happen.  I hope Obama respects this reality, but more importantly that people respect this reality and don’t play the blame game too quickly.  You can only play the cards you are dealt.  Tough decisions will have to be made and the consequences endured.

Transaction Environment

The transaction environment continues to be impaired.  A lack of available debt capital will keep, to a large extent, transaction velocity involving the private equity community at anemic levels.  Sellers who don’t need to sell, and who were targeting private equity, are doing what you might expect, staying away.  Strategic sellers, are marshaling their resources and hunting for bargains.  I believe we should prepare for 12 months in the doldrums, a la 2001.

That notwithstanding, what can we expect from the new regime?

What We Know:  At the highest level, Obama has a more narrow view on issues of antitrust than the prior presidential regime.   After all he is a Democrat (see Clinton v. Microsoft).  Obama will ask regulators to take a harder look at monopolies,  duopolies, oligopolies and the like.  However, any efforts to really do anything about this will be hampered by Republicans on the bench who will toe to historical norms. Expect some gridlock.  Further, the Obama regime must look at deals through the lens of what is best for the job market.  Absent cost effective debt or equity a number of businesses would otherwise fail and might be better off in the hands of corporate consolidators.  The first litmus test will be the automotive industry, which might be more cost effective to rationalize then save on a case-by-case basis.

What we also know is that Obama will change the capital gains rates related to proceeds from sales of corporations and corporate equities, treating them as ordinary income.  This is expected to have a chilling effect in the private middle market as there was a rush to the exits in light of the possibility the capital gains rates would be altered.  For many it will be hard to stomach sending more to the government today, as opposed to waiting a cycle and hoping the pendulum will swing in the other direction.  That said, now would be a great time as a business owner to set up a charitable foundation while you can justify the allocation of equity securities at a reduced price.

What We Believe: On the flip side of the above, we are hearing about tax breaks on capital gains for investments in businesses with enterprise values below $50 million.  This would be favorable to the venture community, which puts money to work in companies that are long on top line growth and short on profitability, and lower middle market private equity.  However, this could simply lead to a gerrymandering of initial investment basis to get below the valuation threshold.  This, in my view is not good for business or the transaction environment.

We also expect changes in the tax treatment for carried interest, which has historically been taxed as capital gains.  This is not so much an initiative spearheaded by team Obama, but rather a function of the changing dynamic in the balance of power within Congress.  Retiring Congressman Tom Reynolds was a significant factor in pushing aside/sweeping under the rug the issue last year.  Since the Democrats did not have the votes necessary to enact wholesale changes, they were left with only one option — back down, for now.  Due to election gains, they now have the votes, and we should expect the issue to resurface and changes to be enacted.  This will effectively change the value proposition for private equity pros.  While it is unclear how this will carry through to fund formation, structure and limited partner agreements, it may manifest itself in lower valuations for sellers as funds try to drive IRRs higher so as to offset the tax implications.

What I Hope: Most of the topics discussed above are expected to have a cooling effect on the transaction environment.  In order to offset these impacts, we need a robust initial public offering market and a strong equity market, that allows for strategic buyers to make up for a decline in leveraged buyouts.  However, a healthy thawing of the credit markets would provide ample incentive for private equity funds to get back to putting money to work.  I hope Obama leaves both capital gains and carried interest alone.  I don’t expect either to happen.  I should be put in a straight jacket for just thinking the thought.  As such I hope, Obama does more than his predecessors to offset the impact of these policies for small business owners.  After all, many of them will get trapped by the income tax increases at the personal level Obama is proposing.  Beneficial changes could include simplification of the code to lower the cost of compliance, finding ways to lower the cost of health care for these companies or programs such as the Advanced Manufacturing Fund and Manufacturing Extension Partnership.  Net net, business owners are going to get squeezed as individuals even while their companies receive relief.

With the arrival of Barack Obama there is renewed optimism in this country, after the last few years of ever increasing doom and gloom both here and abroad.  I have high hopes for an Obama presidency, but tough choices will need to be made.  I suspect how Obama manages himself on the field of foreign policy will have a significant impact on his ability to tend to his own backyard (I know I am full of more cliches than junior league hockey coach).  Of signficance will be weather the Federal Reserve can get the bailout right and pull out injected liquidity before it results in significant inflation.  That all being said, I feel that we as a nation are better off economically with an Obama presidency despite the fact his policies should have negative implications on transaction velocity involving private capital.

/bryan

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