Raising private equity money in Germany is difficult at the moment. Public equity valuations are still falling, and plunging stock markets are never good news for private equity funds. Uncertainty is always disruptive. Then the markets settle and a buying opportunity opens.
But never mind investing, first you need to raise the capital and that is easier said than done as investor's equity portfolios go through the floor and allocations to private equity start to bulge relative to their quoted counterparts.
German insurance companies such as Allianz, Ergo and Munich Re are important investors in private equity in Germany. But at present it may well be that the only fundraising the insurance industry is really interested in at the moment is for bail-out funds for failing insurers. A nervous private equity industry is yet to test whether the insurers still have any appetite for the asset class. The early signs are positive but very much on a case-by-case basis. As in the public markets, the enduring story in private equity is the flight to quality.
Collapsing equity markets on their own would make fundraising tough enough. But the shelf of reference books that is the German tax code – never mind the quality, feel the width – is riven with such uncertainty that for anyone thinking about raising a fund in Germany, a simple piece of advice is tempting: move to the UK and raise it there.
Michael Kreft, a partner with SJ Berwin Knopf Tulloch Steininger in Munich, says: ?At the moment very few new German funds are created. For people that are thinking about creating funds for investors in Germany, the answer is more and more to move to London or the Channel Islands.?
There are several taxation issues for private equity managers looking to raise a fund in Germany. The left-of-centre coalition government, could very easily have won some rich and influential friends by taking action. But according to many in the private equity industry, they have sat on discussions for 18 months and have now postponed any decisions until after the elections.
Meanwhile Edmund Stoiber, Schroeder's rival in the elections, has chipped in with his own depressing election promise: the return of capital gains tax, ostensibly to boost flagging federal coffers. Germany's private equity players are more concerned it will damn deal flow.
Those interested in fundraising also face further uncertainties. Germany's private equity community is still waiting to discover whether proposals to treat private equity partnerships as trading partnerships, which would make them liable for trade tax, will receive the green light.
Kreft does not expect a final judgement on this until the end of the year. The industry has been in paralysis ever since the proposals were first announced a year ago. One manager says: ?It was a group of bureaucrats in Berlin, who wanted to close a tax loophole. They just pulled out a load of tax judgements that weren't relevant to private equity and based the recommendations on that. It took the industry by surprise and now it is in shock because 12 months later it is still on the table.?
Maximilian Brönner, a partner at LGT Capital Partners currently managing over €2.9bn in private equity and hedge fund investments, highlights the damage the current taxation regime does in holding back the development of the investor base in Germany. He says: ?The whole tax situation is rather difficult and definitely needs a sudden clarification. It has been difficult for pension funds to invest in private equity in case it is seen as a commercial activity rather than an investment in an asset class.?
He says that if a €5bn pension fund, considered a tax-free vehicle, made an allocation to a private equity fund but had the wrong structure, it could suddenly find itself liable for a tax bill on its entire €5bn in assets, because it had been infected by the commercial status of the private equity fund. Avoiding such a situation is possible, but complicated and inefficient.
Jeremy Golding of Golding Capital Partners, a Munich-based fund of funds manager, is deeply frustrated by this state of affairs. He says: ?There has been no progress for a year, despite it going to the highest level. No decisions have been taken, but perhaps any decision would have been better than none. At least we would have a ruling and tax lawyers could find a way round it.?
As it stands there are proposals on the table and nobody knows where they stand. Will past practice hold or should current practice try to take into account the possibility of the rulings changing?
Golding says the real victim will be the German economy. Its corporates need to restructure, but the banks are retrenching and if the German government fails to act there will be no private capital to take its place. It looks bad for foreign investors too. Golding says: ?The question is simple, does the German government want to promote private equity, do they understand the significance for the economy, not just now but in the future.?
If they do not then the investors will go elsewhere. They are mobile and international, and the fear is that they will turn their back on Germany, which will stifle the development of a desperately needed group of home-grown private equity managers.
Another debate that is still ongoing focuses on whether the carried interest payable to managers on a successful fund should be subject to capital gains tax (and thus, under current legislation, remain tax exempt) or income tax. Although this would not necessarily impact directly on an investor, if income tax should indeed apply, few would bet against general partners paying out to limited partners only after they had taken into account their own tax bills.
Brönner says that despite these issues there is still money out there for the right team with a demonstrable track record, but managers on a first-time pitch do not stand a chance. Investors are split into two groups between those who shy away from the assets long time horizon and illiq-uidity and those who embrace the asset class for its reduced volatility and superior returns, compared to the public markets.
Brönner believes the two groups balance each other, but that investors still committed to the industry are putting it under closer scrutiny. He says: ?Now it is survival of the fittest. Good firms are seeing more money than they ask for. If you don't have a track record, the same team and a consistent investment philosophy, then it is impossible.?
There is a shake-out taking place in Germany's private equity and venture capital industry. The fund-raising process is as hard as it has ever been, hindered by red tape, confusion and a dire economy. But as Brönner says: ?The teams that survive will be the good teams, the teams for the next decade. But only a few will survive.?