How Private Equity Firms Can Leverage Tax Credits and Incentives To Influence Above-the-Line Growth and Incremental Free Cash Flow

Adam Taplinger

Private Equity (PE) firms can take advantage of underserved areas of margin opportunity across the portfolio now.

Fund managers do not have the bandwidth to get into the weeds on tax credits. To that end, they should look to advisors that can identify tax credit optimizing strategies that positively impact portfolio companies’ operating and net margins. A top-down approach quickly identifies and quantifies opportunities within the fund by asking three key questions:

  • What tax credits are available to each company? (e.g., Employee Retention Credit, Work Opportunity Tax Credit, R&D Tax Credit, etc.)
  • Is the portfolio company maximizing the credits it may be currently taking?
  • What are the cost-saving opportunities for proposed or recently completed acquisitions?  Understanding these opportunities can help a sponsor build more complete buy-side models. It can be used to tighten up an investment committee thesis or help support a dialogue with lenders. 

Getting the ‘big picture’ right.

Let’s take a hypothetical scenario around the Employee Retention Credit, using a fund that is currently invested in 20 portfolio companies. The fund does not have an advisor to provide ‘big picture’ guidance. Some of the companies took ERC while others had not. Those that had not are looking to the fund to support the calculation. The CFO’s at the company level all have a different lens on what they believe to be the correct determining factors for eligibility as well as qualified wages. 

In most instances, portfolio companies of private equity firms can determine eligibility at the fund level. Meaning, if another majority-owned company in the portfolio was suspended by government order, all majority-owned companies in the portfolio may also piggyback on that suspension. This fact is not widely known, and therefore some of the finance leaders believe that they are ineligible and do not claim the ERC. Others claim ERC but do not make the correct assertions with respect to the factors that determine eligibility.

Minimize post-diligence surprises and find free cash flow a seller might be leaving on the table.

A change in control can create opportunities for credits. Take for example, a public company divesting a non-core software business. The public company may have taken a PPP loan, and therefore may have been ineligible to receive the Employee Retention Credit. A sponsor buying that software business may be able to claim the ERC. The buyer should also determine if the seller was maximizing its R&D Tax Credit. These two credits have the potential to provide several million dollars of incremental cash to the newly acquired company in the form of both above and below the line tax benefits.

Don’t leave money on the table. A sound tax credits strategy helps maximize EBITDA, Net Income and Free Cash Flow. Look to a sponsor solutions team that understands how to create value and unlock liquidity.

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