PE Week Wire: Thursday, November 6, 2008

Remember that big debate over how the IRS should treat carried interest, in which certain agitators (hello mirror) argued that such profits more closely resemble ordinary income than capital gains? Well, it effectively ended Tuesday night at 11pm ET, when Barack Obama corralled his 270th electoral vote.

Momentum for such a change stalled late last year, due largely to vocal opposition from President Bush and GOP Congressman Tom Reynolds. It also didn’t hurt that private equity was wiped off the front pages by credit concerns, but this was more about political power than political posturing.

Now, however, the playing field has been dramatically altered. Bush will be replaced by Obama, who signaled 18 months ago that he supports a change to carried interest tax treatment. The retiring Reynolds will be succeeded by another Republican (Chris Lee), but not by one with nearly the same seniority or influence. Plus, the Democrats will have much stronger majorities in both houses of Congress.

All of this adds up to carried interest being treated as ordinary income, perhaps by as early as 2009.

I’ve already heard some PE pros downplay the possibility, believing that this is an issue that has been forgotten behind the back burner. Moreover, they argue that the cap gains rate is going to rise regardless, so the marginal increase of shifting carried interest will do little to raise federal revenues (particularly given how little carried interest will actually be generated next year).

All good arguments, but not good enough. The public optics of this move still works for Democrats, and I’m not expecting much self-restraint from Charlie Rangel, Barney Frank, Sandy Levin, et all. Alan Patricof acknowledged as much during our keynote interview in Quebec City last Tuesday, when he said investors were fooling themselves if they didn’t expect the carried interest issue to be resurrected.

What may be particularly interesting to watch will be how the matter could further cleave the venture capital and buyout industries. Both industries structure their funds the same way, and would theoretically be affected equally by a change to ordinary income. But last year we saw the National Venture Capital Association try to argue that its members should be excluded from any rules change, because venture capital is a force for good while buyouts are a force for evil. Well, they weren’t quite so explicit, but that was the undercurrent. In fact, one NVCA member said that the group had intentionally not joined lobbying forces with the Private Equity Council, in order to maintain its pristine independence.

VCs have reason to think Obama might be sympathetic to them, as his economic plan includes a capital gains exclusion for investments in “small businesses.” This could lead to all sorts of wrangling over just what will constitute a “small business” going forward, and could even prompt some multi-stage VC firms to refocus on early-stage investments.

But that’s all speculation. All we know for sure is that carried interest and capital gains are soon to part. And pardon me for saying so, but it’s about time.

*** The latest issue of Venture Capital Journal is out, including a piece Alex wrote about how VC-backed cleantech companies have been squeezed by the credit crunch (particularly those companies in need of project financing). Non-subscribers can read it for free here.

If this is a subject that interests you, VCJ also is hosting a related breakfast discussion on January 13 at the Quadrus Center on Sand Hill Road. It costs just $60 to attend, and you can sign up here.

Top Three

Leonard Green & Partners have acquired around a 17% stake in Whole Foods Market Inc. (Nasdaq: WFMI), for approximately $425 million.

The Blackstone Group reported a Q3 loss of $502.5 million, compared to a $299.2 million gain in Q3 of last year. This included -$68.3 million for its private equity portfolio, which was mostly attributed to a reduction in the carrying value of its portfolio companies. It also deployed about 35% less limited partner capital.

Goldman Sachs notified around 3,200 employees this week that they have been laid off, as part of previously disclosed plans to cut 10% of the firm’s global workforce.

VC Deals

Prolexys Pharmaceuticals Inc., a Salt Lake City-based developer of cancer drugs using a proteomics technology platform, has raised $20 million in Series A-1 funding led by Friedli Corporate Finance. The company has previously raised around $85 million, but this is its first round since transitioning its focus from proteomics technology development to drug development.

Mogreet Inc., a Venice, Calif.-based provider of video messaging solutions for mobile phones, has raised $5 million in Series B funding. Ascend Ventures, Black Diamond Ventures and Spyglass Ventures were joined by return backer DFJ Frontier.

GetBack Media Inc., a Los Angeles-based online pop-culture community, has raised $1.7 million in Series A funding. Beringea led the round, and was joined by undisclosed angel investors.

Blue Square Energy Inc., a North East, Md.-based solar cell manufacturer, is looking to raise upwards of $25 million, according to VentureWire. The company is so far backed by $6 million in angel funding.

Buyout Deals

American Furniture Corp., an Albuquerque, N.M.-based furniture retailer, has filed for Chapter 11 bankruptcy protection. The company said that it plans to keep its stores open, while working “to restructure the company’s debt and realign its business operations.” Hancock Park Associates acquired a majority stake in AFC in 2005 for an undisclosed amount.

American Securities has acquired Liberty Tire Services LLC, a Pittsburgh-based tire recycler. No financial terms were disclosed.

Centerplate Inc. (AMEX/TSX: CVP) said that National City has reneged on its agreement to finance its acquisition by Kohlberg & Company, under the originally agreed upon terms. Centerplate said that NatCity had committed to providing $175 million for the deal, and that the bank now wants to renegotiate. Centerplate is a Stamford, Conn.-based provider of food services, including concessions, catering and merchandise services in more than 130 sports facilities, convention centers and other entertainment venues throughou! t the United States and Canada.

Standard & Poor’s has lowered the corporate credit rating of The Hillman Group from ‘B’ to ‘B-‘. It also lowered Hillman’s senior secured bank loan rating to ‘B+’ from ‘BB-‘. Hillman is a Cincinnati-based! maker of fasteners, signage and other small hardware components. It is owned by Code Hennessey & Simmons.

PE Exits

Amdocs (NYSE: DOX) has acquired Changingworlds Ltd., a Dublin-based mobile phone advertising company, for $60 million in cash. Changingworlds had raised just under $4 million in VC funding led by Trinity Venture Capital.

enChoice has acquired CYA Technologies, a Shelton, Conn.-based provider of enterprise content backup and recovery solutions. No financial terms were disclosed. CYA had raised around $10 million in VC funding from H.I.G. Ventures and Connecticut Innovations.

Firms & Funds

3i Group announced that its first-half revenue was down 43 percent.

Human Resources

James Fraser has joined Permira as head of financial services. He previously was with L.E.K. Consulting, as co-head of its global financial services practice.

Panorama Capital has promoted Michael Jung to partner. He previously was a principal with the VC firm, and serves on the boards of Axiom, World Golf Tour, Shopflick and Zilliant.

Eugenio Galdon reportedly will step down as chairman of Spanish telecom operator Ono, due to pressure from investors like CCMP Capital, Thomas H. Lee Partners and Quadrangle Group.

James Walling has joined SVB Analytics as head of valuation services. He previously was with PricewaterhouseCoopers.