By early 2007, it was clear that the rapid growth of private equity was inciting a wave of public opposition in both the US and Europe. That is why our industry established the Private Equity Council in Washington to explain our case. At the time, I personally expended much time and effort educating the media on this subject.
I wish our efforts had been more successful. Since 2007 two tax changes have hurt our industry's profitability. Several countries in Europe, including Germany, have followed Denmark's lead in removing the tax deductibility of interest payments for leveraged buyouts. Although the US did not follow, the Internal Revenue Service has succeeded in forcing a change in the tax treatment of private equity's performance fees (known as the "carried interest"). Previously, the carried interest was taxed at the capital gains tax rate of 15%. After this tax loophole was closed, these fees have been taxed at corporate rate. This change wiped nearly 20% off our 2008 earnings.
The buyout backlash worsened after the recession, which was accompanied by bankruptcies at several high profile LBOs. During the Senate hearings into the private equity industry, the dismal performance of many buyout funds, especially the 2006 and 2007 vintages, came under scrutiny. The fees charged by private equity firms were also widely criticized in the light of losses experienced by many pension funds. It is scarcely an exaggeration to say that private equity has become the scapegoat for all our economic woes. The upshot was that public pension plans have been forbidden by federal law from making any further buyout investments. This has been a serious blow. Up to that date, public pensions accounted for around 40% of Blackstone's investor base.
Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports.