How SBIA Aims to Help the Little Guy

Public policy that impacts private equity is often modeled on large funds. The Small Business Investor Alliance’s Brett Palmer, and a COO of a member PE firm, discuss a couple of pieces of legislation they’re championing to help lower-middle-market PE funds.

In the world of lower-middle-market private equity funds without the capacity for a large back office, taxes are a big deal. They have a huge impact on the way investments are made.

The president of the Small Business Investor Alliance (SBIA), Brett Palmer, is working to get several bills through Congress that aim to help those funds at the smaller end of the private equity spectrum. “In public policy market circles—especially taxes—it’s easy to look at the big numbers, and the lower middle [market] is ignored. It’s very easy to talk about carried interest in a negative light.”

The issue of carried interest impacts smaller funds to a much larger degree than the big names, says Palmer, as there is a smaller base of capital to earn fees, get returns, and create wealth by “really earning money for investors, not just collecting fees. If you have a $100M private equity fund, you’re running pretty lean. There’s a scale difference as far as the [amount of] pain—both regulatory and tax. With a smaller fund, the carry can be 80 percent over 10 years. A larger fund is 20 to 30 percent. The smaller fund feels more pain.”

Palmer gathered recommendations of changes to tax codes from SBIA members and submitted them in a letter to the bipartisan tax working groups of the U.S. Senate Finance Committee. Smaller private equity funds are more likely to invest in small businesses, which drive a lot of job creation in the U.S. But many of these small lower-middle-market funds are affected by tax policy, and Palmer says the SBIA is looking to give them a voice. Last year they focused on the House Ways and Means Committee, and this year it’s the Senate Finance Committee.

“If you don’t have a seat at the table, you will be on the menu,” Palmer says. “If you’ve looked at all of the negative stories with carried interest…we have to tell our part of the story. A lot of people in private equity tried to ride on the coattails of the largest funds during Dodd Frank [and found out the hard way that] if they don’t engage, they’ll be paying the price later on.

“That issue [carried interest] has been demagogued more than any tax issue around,” Palmer adds.

The Riverside Company, an SBIA member, believes that retaining the character of carried interest as a capital gain is critical for PE firms that invest in small- and middle-market businesses, says its chief operating officer, Pamela Hendrickson. This is one of the “three big issues” facing lower-middle-market PE firms, she says, adding: “A change to carry really impacts these private equity firms because their asset base is lower. They’re taking the risk by investing in long-term capital assets and are then reliant on generating great returns to ensure that people who are doing deals in these firms are rewarded for the risks they’re taking.”

He says there are about 10 different pieces of legislation moving at the same time. A regulatory example included in this total is the Small Business Investment Company (SBIC) Capital Act of 2015, co-sponsored by senators Jim Risch (R-ID) and Ben Cardin (D-MD). The bill was introduced in the Senate in April in order to raise a statutory cap restricting proven small business investors from accessing new leverage. According to the SBIA, as many as 40 SBIC “family of funds” investors are hitting the cap, or will hit the cap, if they raise their next fund.

Riverside is one of those. Hendrickson says that the family of funds limit increase is also on her wish list of legislative reforms. “The SBIC program is great, but the challenge is if you have multiple SBICs, you can run up against the limit pretty quickly,” she says. “The proposal is to raise it to $350M, which would be great. Funds that are SBICs are attractive, and we would like to be able to take more advantage of the program.” The current limit is $225M.

Giving smaller shops more investment latitude will ultimately help small businesses. “Big funds cannot invest in small businesses,” Palmer says. “If you have a multibillion-dollar fund, it’s inefficient to do so. [But] if you have a $200M fund, you can do lower-middle-market investing. You have to have funds to scale with it.”

The SBIC bill will have a hearing in the House in May. Palmer says the SBIA also anticipates that legislation will be introduced soon to help modernize business development companies, and another in this session of Congress to help middle-market private equity.

“The general theme is that lower- and middle-market businesses cannot ride the coattails of the largest funds,” Palmer says “We learned that doesn’t work.”