Common tax risks that result in value erosion on private equity exits
Beware of little expenses. A small leak will sink a great ship.
The below are some real life examples of value leakage suffered by private equity mangers on European portfolio exits.
The seller had missed spotting interest withholding tax obligations that had been triggered due to ‘change of lenders’ in the syndicate. In addition to suffering a material price chip, substantial time and cost was incurred in having to deal with the issue during an exit process.
There was no tax valuation undertaken on sweet equity issued to management during the couple of years leading up to exit. The seller suffered a heavy (high nine figure) price chip. Both sides’ advisors spent hours haggling the issue and a complicated SPA ensued.
Poorly managed tax residency ended up being a deal killer. The assumption of zero capital gains tax ended up being a material capital gains tax exposure. No deal was the result!
Lack of good board minutes and documentation of investment intention resulted in a large price chip on a real estate deal for the seller.
Lack of transfer pricing documentation and interest deductibility analysis (anti-hybrid) led to substantial amounts being held in escrow at closing.
The above is by no means an exhaustive list; and, similar issues are frequently identified on private equity deals. In a majority of the cases, unless the exposure ends up being a deal breaker, a price is agreed or the risk insured and forgotten.
Whilst the value leakage per deal may appear less painful; when you add these up across all the exits made by a fund during its life, it is likely to result in a meaningful hit to a fund's IRR.
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