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Private equity's choice: Obama or Romney

November 5, 2012: 1:25 PM ET

Illustration: Edel Rodriguez

Will Obama or Romney be better for private equity?

FORTUNE -- In 36 hours or so, we should know if America has elected its first-ever private equity president. Or if it's reelected the guy who campaigned, in part, by criticizing some of private equity's more controversial practices.

Based on the rhetoric, it seems obvious that Mitt Romney should be the choice of private equity professionals who vote their business interests. But I'm not so sure that it's quite so clear-cut.

For starters, future private equity success will depend more on a vibrant economy than on any industry-specific policy. Not only because a rising tide lifts portfolio company financials (and, in turn, sale prices), but also because private equity relies on capital commitments from a wide swath of  institutional investors (public pensions, college endowments, corporations, family offices, nonprofit foundations, etc.).

So if a private equity voter is convinced that Romney's economic policies are best for broad-based prosperity -- both in America and worldwide -- then he should be the pick. Same goes for Obama.

And before calling this a cop-out, two opposing pieces of data: Romney has raised far more money from private equity execs than has Obama, and also seems to have their ballot box support. At the same time, Cambridge Associates reports that private equity has generated 16.62% benchmark returns in the three years between June 30, 2009 and June 30, 2012. That's better than the private equity benchmark for any other time period that CA measures, and was based largely on a public equities market that has thrived under Obama's watch.

Again, not clear-cut. And macro economic prognostication is an educated guessing game, at best. So let's take a look at what we do know about each candidates, vis-a-vis private equity:

Carried interest taxation

Obama: Barack Obama campaigned five years ago on changing the tax treatment of carried interest (i.e., the cut of PE investment returns earned by PE execs) from capital gains to ordinary income. And he's done so again this time around, after failing to get it done in his first term. If reelected, there is a strong argument to be made that Obama will finally get his grand bargain -- with carried interest included on the revenue side of the ledger.

Romney: When Mitt Romney ran for the Republican nomination five years ago, he said that carried interest should continue to be treated as a capital gain. This time around, he's steadfastly refused to take a position (despite repeatedly being asked to do so). Romney has, however, based almost his entire tax policy around the closing of unspecified deductions and loopholes. Carried interest is hardly the largest of these, but is certainly one of the most politically palatable (and many of Romney's largest PE industry donors have privately accepted the eventuality, while others like Marc Andreessen have explicitly endorsed such a move).

Conclusion: Carried interest taxation probably is getting changed in the long-term, no matter who gets elected.  The real question will be if the eventual  only affects PE and hedge fund managers, or if it also gets extended to real estate partnerships, energy partnerships, timber partnerships, etc. In the short-term, the greater difference would be on increasing capital gains rates (which is scheduled to occur, with Obama's blessing), having them stay static (which Romney supports) or eliminating them altogether (per Paul Ryan's plan).

Corporate interest deductions

Obama: Barack Obama laid out a framework for corporate tax reform earlier this year, which included an unspecified reduction in the amount corporations can deduct on interest payments (which currently is 100%). Then he barely talked about the framework during election season, nor did he push related legislation (although, in his defense, no major tax bill was getting passed in pre-election 2012). This is a very big issue for private equity firms that base their returns on their ability to significantly increase portfolio company debt, both at acquisition and via subsequent recapitalizations. Obama has basically said that extra equity is preferable to extra debt.

Romney: Like with carried interest taxation, Romney has refused to take a position on this issue. He has talked about broad corporate tax reform that closes deductions, but nothing specific.

Conclusion: Obama will try to make it slightly more difficult for private equity firms to base returns via financial engineering, although likely will be talked into a carve-out for small businesses. If Romney caves on carried interest, look for him to hold the line here. The former is a park of private equity. The latter is, arguably, its lifeblood.

Fundraising

Obama: Barack Obama is typically a strong supporter of public employee unions, which make up the largest single category of U.S. investors into the private equity asset class. That said, private equity fundraising has been quite sluggish under his watch -- with a virtual disappearance of the $10 billion+ megafunds that dotted the landscape in 2004-2008.

Romney: Like many GOP candidates, Mitt Romney has campaigned on reducing the influence of both public and private-sector employee unions. The fewer public sector employees, the fewer dollars there will be for private equity.

Conclusion: Neither candidate can really do much about public employee pension funds -- those are state matters -- so this is likely a non-issue. The only exception would be if Romney began using his bully pulpit to encourage states to move workers from defined benefit to defined contribution plans -- as the latter cannot currently be used for private equity investment, due to the industry's illiquid nature.

Intangibles

Obama: It remains to be seen if President Obama's attacks on private equity have been political rhetoric aimed at his particular opponent, or deeper-held animus toward the industry. My guess is the former, based on two conversations who have put the question directly to Obama in private settings (yes, he may have been humoring them). In general, we should be able to judge Obama based on what we've seen for the past four years -- agitating for higher taxes on the wealthy and some greater reporting requirements via Dodd-Frank, but nothing like the legal restrictions on dividend recaps that we're seeing in Europe.

Romney: No other presidential candidate has ever understood the private equity market better, nor believed in it more as a force for economic good. He will, in most cases, be a reliable ally. It also wouldn't be surprising to see a President Romney litter his Administration with a few current (or former) private equity execs.

At the same time, however, Gov. Romney's ties to private equity could make life complicated when firms come to D.C. in search of regulatory approvals for anything from merger approvals to new portfolio company drilling licenses. Will a Romney Administration analyze such requests on the merits, or on friendships? Even if there is no evidence of the latter, the questions will be asked. This would be especially true if the petitioner is Bain Capital, or any of the other small handful of PE firms to whom Romney has personal, financial exposure. If elected, he would be wise to instruct his (blind) trustee to divest of such positions so as to avoid even the appearance of conflict.

Conclusion: We often elect presidents based on how they promise to handle the problems of today, but ultimately judge them based on their handling of issues that are unknowable on November 6. If some of those issues are to concern private equity, Romney is more likely to be in the industry's corner.

To most Americans, of course, the fate of private equity seems irrelevant. A sideshow specific to the 2012 elections, which will soon slink back into the shadows where it came from.

But remember: Private equity firms are invested in around 15,300 American businesses, which employ more than 8 million people globally. Even if you don't believe that private equity is a net creator or destroyer of jobs -- which is what the best available evidence suggests over the long-term -- it isn't irrelevant. Private equity's outlook and confidence affects its actions, including short-term hiring/firing decisions, where to/where not to expand and how to dispose of investments. And, in turn, those actions affect millions.

Private equity also generates billions of dollars in returns that help fund college endowments, charitable foundations and pensions (not just for public employees, but for corporate workers, church workers, etc.).

Few people, even within private equity, will give serious consideration to private equity's well-being when casting their ballots. But that doesn't mean private equity's well-being isn't in many ways tied to their own. Or to America's.

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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