Story of the year: C-corp switch entices some, leaves others unmoved

Two giant private equity houses became corporations this year while others remain unconvinced of the benefits.

When the federal corporate tax rate dropped to 21 percent from 35 percent in January as part of President Trump’s Tax Cuts and Jobs Act, it got private equity firms thinking: is it worth switching from a partnership structure to a corporation to take advantage of the lower rate?

There are several reasons why making the C-corporation switch doesn’t makes sense for private equity houses, including additional taxes (those at the corporate level and on dividend payouts, as well as various state taxes) and the notion that corporate tax rates may not remain low forever.

That didn’t stop a few large private equity firms from making the switch in 2018. In March Ares Management became the first to become a C-corporation for tax purposes in what Fitch Ratings referred to as “the first domino to fall across the alternative [investment management] industry”. The Los Angeles-headquartered private equity, credit and real estate investment firm abandoned its partnership status in a move designed to expand its investor base.

KKR was next to follow, announcing its intentions in May. Scott Nuttall, co-president and co-chief operating officer, likened the move to going from fishing in a “small pond” to a “big ocean”. The firm’s shares rose to the highest in four years after it completed the move in July.

Will more firms convert in the new year? Some have certainly made their hesitation on the topic clear. Blackstone was “impressed” with KKR’s stock gain following its switch and will be “thoughtful and deliberate” about whether it decides to follow suit, president and chief operating officer Jonathan Gray said in July.

Carlyle Group is also yet to be convinced. “Converting to a C-corp is a no-going-back kind of decision,” co-chief executive Glenn Youngkin said on an investor call in February. The firm will closely examine the effects of a C-corp conversion and will “revisit this topic when appropriate” as the upsides and downsides of such a move become more apparent, he added.

Apollo Global Management, which believes there is some benefit to making the switch, is wary of halting cashflows to the firm’s partners under the limited partnership structure, according to the firm’s co-founder Josh Harris.

“We do think there is some positive uplift in the stock,” Harris said in reference to KKR in October on a third quarter earnings call. “Unfortunately that sort of uplift is going to have to stand the test of time because as we’ve said before, you’re destroying cashflow permanently.”

– Dominic Diongson contributed to this report.