Tag: Private Equity

Strategic Considerations Why Private Companies Should Adopt Public Company Controls

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Often viewed as a “public company problem,” private organizations may want to consider implementation of internal controls similar to Sarbanes-Oxley (SOX) Section 404 requirements. The inherent benefits of a strong control environment may be of significant value to a private company by providing: enhanced accountability throughout the organization, reduced risk of fraud, improved processes and financial reporting, and more effective inclusion of the Board of Directors.

Private organizations, while not always smaller, often have limited resources in specialty areas, including accounting for income tax. This resource constraint—the work being done outside the core accounting team—combined with the complexity of the issues, means private companies are ideal candidates for, and can achieve significant benefit from, internal controls enhancements. Thinking beyond the present, the following are five reasons private companies may want to adopt public-company-level controls:

  1. Future Initial Public Offering (IPO) – Walk before you run! If the company believes an IPO may be in its future, it’s better to “practice” before the company is required to be SOX compliant. A phased approach to implementation can drive important changes in company culture as it prepares to become a public organization. Recently published reports analyzing IPO activity reveal that material weaknesses reported by public companies were disproportionately attributable to recent IPO companies. Making a rapid change to SOX compliance can place a heavy burden on a newly public company.
  2. Private Equity (PE) Buyer – If the possibility of the company being sold to a PE buyer exists, enhanced financial reporting controls can provide the potential buyer with an added layer of security or comfort regarding the financial position of the company. Further, if the PE firm has an exit strategy that involves an IPO, the requirement for strong internal controls may be on the horizon.
  3. Rapid Growth – Private companies that are growing rapidly, either organically or through acquisition, are susceptible to errors and fraud. The sophistication of these organizations often outpaces the skills and capacity of their support functions, including accounting, finance, and tax. Standard processes with preventive and detective controls can mitigate the risk that comes with rapid growth.
  4. Assurance for Private Investors and Banks – Many users other than public shareholders may rely on financial information. The added security and accountability of having controls in place is a benefit to these users, as the enhanced credibility may impact the cost of borrowing for the organization.
  5. Peer-focused Industries – While not all industries are peer-focused, some place significant weight on the leading practices of their peers. Further, some industries require enhanced levels of security and control. For example, utility companies, industries with sensitive customer data (financial or medical), and tech companies that handle customer data often look to their peer group for leading practices, including their control environment. When the peer group is a mix of public and private companies, the private company can benefit from keeping pace with the leading practices of their public peers.

Private companies are not immune from the intense scrutiny of numerous stakeholders over accountability and risk. Companies with a clear understanding of the inherent risks that come from negligible accounting practices demonstrate their ability to think beyond the present, and to be better prepared for future growth or change in ownership

2020 Private Equity Tax Strategy Considerations

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Key strategies for maintaining a strong offensive tax position during times of economic distress, particularly during the current COVID-19 pandemic, include finding money, preserving cash and planning for future success.

While the affiliation rules associated with the Paycheck Protection Program (PPP) precluded many private equity-backed portfolio companies from qualifying for PPP loans, it is possible to find money through three simple tax actions. First, businesses can now carry back net operating losses for five years, meaning that tax losses from 2018, 2019 and 2020 can be used to offset income from the prior five years for a quick cash refund. Second, businesses with any remaining alternative minimum tax (AMT) credits can also get a quick refund by electing to make all such credits refundable for 2018. Finally, businesses can get a tax credit of up to $5,000 per employee for employees kept on payroll during the pandemic, even if those employees are providing partial services for their compensation.

There are several ways to preserve cash at the moment, starting with deferring tax payments. Businesses can now defer employer payroll taxes otherwise payable for the period from March 27, 2020, through December 31, 2020. Half of the amount can be deferred until December 31, 2021, and the other half until December 31, 2022. Employers that received PPP loans can only defer payroll payments until the loans are forgiven, except that amounts deferred before the loans are forgiven can be deferred 50/50 until December 31, 2021 and 2022. In addition, payment (not just filing) of 2019 taxes can be deferred until July 15, 2020.

On top of these deferrals, 2019 and 2020 taxes can be reduced by taking a higher interest expense deduction than was previously allowed. Under the Tax Cuts and Jobs Act of 2017, businesses could only deduct interest expense up to 30% of adjusted taxable income (ATI), a computation that is similar to EBITDA but may differ in some important respects. For 2019 and 2020, the deductible amount has been increased to up to 50% of ATI. Not only that, 2019 ATI can be used to calculate 2020 interest expense deduction. Finally, businesses can take 100% bonus depreciation on qualified improvement property, a defined term that generally combines three previously separate categories (qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property).

To plan for future success, we recommend businesses use this time to focus on setting an action plan. Businesses should review any diligence reports from the last 12 to 24 months, address any material issues and review acquisition documents to confirm receipt of any benefits to which they’re entitled (e.g., any net operating loss carryback opportunities).

Businesses should also take this time to consult with tax advisors about state income tax credits and business incentives reviews, as well as consider a reverse sales tax audit to see if a refund of overpaid use taxes is available. In addition, this is a good time to make sure sales tax is being filed properly, especially given numerous changes to sales taxes (with some jurisdictions even taxing services) as well as the Wayfair decision, which permitted states to expand sales tax filing obligations to an economic rather than a physical basis. Sales taxes are generally accepted as a customer tax, unless the business is audited, in which case the business pays.

Although not really a tax, a reverse unclaimed property audit may also be considered. With tax revenues plummeting, states will likely be looking for sources of additional revenue and unclaimed property may be low hanging fruit. This is especially true for businesses incorporated in Delaware, an aggressive state when it comes to unclaimed property.

The government has been providing tax as well as financial aid at a ferocious pace, including additional guidance and expanded (and sometimes nuanced) benefits. While we have outlined some of the bigger benefits currently available, businesses should consult with their tax advisors about these and other tax opportunities.