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Governor candidate Biss is a traitor, say private-equity investors

Crain's Chicago Business

Saturday, June 17, 2017  |  Article  |  Lynne Marek

Taxes, misc. (89) Biss, Daniel--State Senate, 9

Chicago's private-equity industry once considered gubernatorial candidate Daniel Biss an ally, but his "privilege" tax bill has made the state senator an enemy. The legislation, which passed the Illinois Senate last month and awaits action in the House, would hike taxes on private-equity investment gains to close what Biss calls a loophole benefiting ultra-rich money managers.

A battle over the issue has raged for years at the national level, but the federal government hasn't implemented such a tax, so some states are taking action. While business investors would normally trust Gov. Bruce Rauner, a former private-equity executive, to veto the legislation, the industry's trade group fears the unpopular Republican may cave in an election cycle that pits him against Biss and a pack of other Democratic contenders.

"We would definitely sue" if this bill became law, says Maura O'Hara, executive director of the Illinois Venture Capital Association, which represents private-equity and venture-capital firms. She argues the bill singles the industry out for a tax boost and is unconstitutional.

But Biss, of Evanston, says he's simply righting a federal wrong. "They're being singled out by the federal government that gives them this unfair loophole," says Biss, who contends investors can't call income earned on other people's investments a "capital ​ gain." "We're correcting that mistake." And it would help ease the state's financial crisis, he insists.

New York, New Jersey, Massachusetts, Rhode Island and Connecticut are pressing similar legislation in a regional effort.

President Donald Trump backed a change to the 1990s-era federal tax policy on the campaign trail last year, but his administration hasn't pushed it, despite support from top Democrats.

Chicago private-equity members of the Venture Capital Association include Rauner's former firm, GTCR, as well as Madison Dearborn Partners, Thoma Bravo, Roundtable Healthcare Partners and Pritzker Group Private Capital, formerly led by billionaire J.B. Pritzker, who recently left leadership of the business to his brother Tony Pritzker while he runs as a Democrat for the state's top office.

Private-equity firms raise money from pension funds, foundations and high net worth individuals to buy private companies with an eye toward selling them for a profit. Often, they expand the companies with acquisitions and cost-cutting over three to six years. Typically, double-digit returns are shared by firm partners and their clients.

Illinois private-equity firms invested $22.6 billion in 164 companies last year, O'Hara says. The bill also would apply to venture-capital firms that back startups, but that's a smaller pool of funds, with $1.3 billion invested in 251 fledgling companies last year.

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The gains firm partners reap on increased company valuations, called "carried interest," are taxed by the federal government at between 15 to 20 percent (depending on partners' federal income tax bracket) instead of income tax rates of as much as 39.6 percent.

WILL FIRMS FLEE?

If the Biss bill becomes law, it would impose for the first time a state tax of 20 percent on Illinois private-equity firms, as well as venture and hedge fund firms, for the investment gains they achieve for clients. That would drive investment firms out of the state, O'Hara says. An Illinois Department of Revenue analysis suggests she may be right. It predicts $1.7 billion in additional revenue the first year, but a wash in later years as firms leave or reclassify income.

J.B. Pritzker agrees that Illinois firms might flee, and take jobs with them. "I favor a federal law to close the carried interest loophole nationally, which would create an even playing field across states and ensure Illinois is not disadvantaged in drawing investment capital to our state," he says in a statement.

Some private-equity executives feel betrayed by Biss, whom they supported earlier in his political career. One of them is Limerick Investments Managing Director Bob Fealy, whose firm invests in early-stage companies. He also formerly made private-equity investments on behalf of the wealthy Duchossois family and is a former chairman of the Venture Capital Association's political action committee.

In a letter he wrote to Biss last month, he asked the state senator to return more than $5,000 in campaign contributions. "I can't describe how disappointed I am in your sponsorship (and authoring of) this bill," Fealy said in the letter. "Surely you must understand the catastrophic impact this will have on investment management firms located in Illinois—I can only conclude you don't care."

Private-equity executives formerly teamed with Biss in 2002 on launching a state treasurer's fund to invest in local venture firms. While they also disagree with Biss on increased fee disclosure by private-equity firms investing money for Illinois pensions, O'Hara sees that as less offensive because the industry is moving in that direction anyway.