Private equity professionals may want to consider a different and potentially more efficient way of donating to charity.
Whether at their own firms or their portfolio companies, private equity professionals embrace efficiency in all its forms. Increasingly, this habit is carrying over to their charitable giving.
Both the donor and recipient public charity can derive significant tax efficiencies from the contribution of private equity interests that are often held by PE professionals - and, more generally, any non-publicly traded assets. Giving these types of assets instead of cash can significantly increase the size and impact of a charitable gift.
Non-publicly traded assets, also known as complex or illiquid assets, that can be donated to public charities include private C corporation stock, S corporation stock, limited liability company interests, limited partnership interests and real estate.
Donating non-publicly traded assets offers several efficiencies and advantages. The donor doesn't incur a capital gains tax on appreciation, and the donor is entitled to a charitable income tax deduction for the independently evaluated, fair-market value of the charitable contribution. For the charity, the subsequent seller of the asset or recipient of distributions generally does not pay capital gains tax. These combined tax efficiencies can sometimes enable donors to give 20 percent to 30 percent more to charity than they could have to a non-charity recipient, even in donating the exact same asset.
The first point to remember is that the assets must be donated outright to a public charity; selling or liquidating the assets prior to the donation would negate the benefits. If these same private business interests were contributed to a private foundation instead of directly to a public charity, the donor could claim only a charitable income tax deduction equal to the original tax basis in the donated asset.
Because of these tax treatment differences, many donors who already have formed a private foundation are choosing to contribute these complex assets directly to a public charity. Donors who wish to have their charitable gift go to many charities, however, are increasingly choosing to make their contribution to a charity with a donor-advised fund program, a charitable vehicle that allows donors to make contributions to a dedicated account at a public charity, from which they may then recommend grants to many other charities.
Donors should consider valuation, timing, liquidity and liability factors when weighing a potential charitable donation. Donors will usually want to contribute their most highly appreciate asset or assets. Any compliant transfer to a public charity must occur prior to any binding commitments to sell the underlying business. Charities prefer to accept assets that are likely to provide liquidity in the not-too-distant future. And the charity's leaders must be secure in the knowledge that owning the assets will not subject them or the organization to potential financial or other types of liabilities.
For the purposes of this article, the term private equity interest encompasses portfolio company stock; limited partner fund interests; general partner interests, typically formed as a limited liability company; special purpose vehicle or co-investment vehicle interests, both typically formed as LLCs; and even interests in a private equity firm.
In assessing whether these types of privately held assets are suitable for charitable donation, it may be instructive to consider four scenarios for a fictional private equity firm: Kind Capital Partners, KCP.
The first scenario would be considering donating an ownership interest in the firm. KCP is structured as a limited partnership. While it would probably be possible to transfer an LP interest in the firm to a public charity, it would not likely be a great asset to give or for the charity to receive. Had the private equity firm been structured as a publicly traded partnership, there may have been a great charitable planning opportunity. If a partner donates his or her private interests to a public charity before they are converted into publicly traded interests, the donor can receive a fair-market value deduction and the public charity does not pay tax when it converts the private interests into public shares.
The second scenario would involve an interest in a fund operated by KCP. A typical private equity fund, formed as a limited partnership, will have an expected term of eight to 10 years. Many charities prefer not to accept an interest in an asset that will not be liquid for many years, so an interest in a specific fund may not be a good asset for charitable contribution until the later stages of its expected term, perhaps in year seven, or later.
The third scenario involves stock in a specific portfolio investment. If the managing directors of KCP can distribute stock of one specific company to themselves before a possible sale, that stock might make a terrific charitable contribution: providing a highly valued fair-market value deduction for the donor, and a high-liquidity asset for the charity.
The fourth scenario involves interests in co-invest vehicles or special purpose vehicles. Many private equity firms form CIVs or SPVs to enable the firm's principals, employees and investors to invest in and share more fully in the profits of select portfolio investments. The CIV or SPV is likely to own interests in a single asset. If that asset is likely to be sold in the near future, holders of CIV or SPV interests can choose to contribute some or all of the interests to charity, and obtain a fair-market value deduction. The related distribution from the CIV or SPV will flow to the charity when the asset is sold.
There is a prominent industry trend toward private equity firms creating more and more CIVs to respond to investor demand. As more firms and investors own interests in these vehicles, the potential for them to fuel the philanthropy of private equity professionals becomes more significant. As CIVs and SPVs proliferate, one could envision each and every private equity liquidity event including tax-efficient charitable contributions.
Already, thanks to these efficiencies - as well as the powerful spirit of philanthropy that is one of the hallmarks of the private equity space - the private equity world is making tremendous contributions to charity. As awareness of the advantages of this method of charitable donation increase, it is possible that overall giving will increase exponentially.
Ryan Boland is a vice president for the complex assets group at Fidelity Charitable, an independent public charity with a donor-advised fund program.
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Corrected June 11, 2015 at 2:58PM: 4358299531001