The Private Equity for Families Blog

A Compelling Case for Private Ownership of Manufacturing Assets — Part 1


It’s what you keep, not what you make!

For the United States, the period 1982-2000 might be regaled by financial historians as one of the greatest periods of wealth creation in the history of the world.  The U.S. stock market, as measured by the S&P 500, grew at an average annual rate of 18% (including dividend reinvestment) during that 18 year period.  Interest rates, as measured by the 10 year treasury, fell from 14% to 5% and  taxes on ordinary income fell from 50% to 39.6%.  Productivity increases through the Internet and computers lifted growth rates for almost all sectors of the U.S. economy.  It was our “Camelot” moment.

On a global basis liquidity and availability of debt were unparalleled as central banks around the world manufactured equally dazzling “Disneyland” prosperity.

Reversion to the Mean

The next 12 years have not been the same.  A stock market crash in 2000 signaled the end of the dot-com boom.  Another and more precipitous crash in 2008-2009, ended a 36 year run for seemingly invincible U.S. real estate markets where the annualized return since 1971 had been 10.3%[1] and signaled the end of an era of prosperity built on debt and accommodative fiscal policies.  The Disneyland economy has seemingly turned “goofy.”

Where do you Invest Now?

Many successful families are questioning what to do next.  Most have substantial cash reserves.  Notwitstanding a robust recovery in 2013 and 2014, most of them also have a lingering distrust of the U.S. stock market, but also understand that they cannot afford to retire on fixed income that is producing below 2% annual returns.  Many of these families are victims of negative real returns where safe interest bearing investments cannot keep up with the pace of inflation.  Instinctively, many of our families want to return to owning something tangible that makes a product which is important to industrial or consumer markets.  Many of their fortunes were converted from manufacturing to financial assets over the last 10 years.  Many may be beginning to regret the timing of that trade.

The case for private ownership of small industrial businesses has never been better; especially if you have the flexibility to utilize tax efficient structures like our model allows.  (More on this in Part Two later in August).

Top Ten Reasons for Small Manufacturers

The macroeconomic model favors private ownership of small manufacturing for these top 10 Letterman reasons.

10. Highly inflationary resistant — Pass on commodity price increases

9.   Small business job creation is a bi-partisan political cornerstone

8.   Private business is private — very little visibility.  You cannot tax wealth creation you cannot see

7.   Long lived illiquid asset based on long-term strategies — not prone to short-term trading during volatile times where you are ruled by fear of loss

6.   Capital gains have almost always been taxed at a substantially lower rate than dividends or interest

5.   Weakness in U.S. dollar due to easy money policies means that U.S. exporters of manufactured goods are benefited

4.   Leveraged private equity model is benefited by an inflationary central bank policy

3.   Profits and taxes can be deferred until the tax climate returns to favorable times.  Our model also allows tax fee dividends while you wait

2.   Wealth is shifted from paper (electronic) net worth to tangible net worth.  Your wealth is converted into means of production

1.   Supply chain miracles in China and Southeast Asia have not been the hoped for panacea. Manufacturing is returning

Back to the Future

On top of 10 good reasons to own a manufacturing company, there is also a realization that the U.S. may return to the era of high taxation that I saw in 1976 when I started my career.

1976 2012 2014
Ordinary Income 70.0% 35.0% 43.4%
Capital Gains 49.6% 15.0% 23.8%
Dividends 70.0% 15.0% 23.8%

In 1976, AFTER TAX returns were the measuring stick of a good investment and investors with choices flocked to tax shelters to cushion the blow of a confiscatory tax regimen.  Everyone focused on what they could keep for their families and not on what they could make on paper.

We believe we are returning to a high tax environment.  Hunting successful people and redistributing their wealth through progressive taxation has again become the favored political sport.  AFTER TAX investment returns will become extremely important.  What you keep will become more important than what you make.

Flexibility to Lower Taxes

Because our investors are taxable, we can buy manufacturing companies with flow through investment entities that grow tax basis above the original invested amount. By running portfolio company operating earnings through our investors’ tax returns, we create a tax shield for future dividends.  It creates a level of complication at tax time, but our research shows that our structure creates a material AFTER TAX advantage over other private equity funds that have institutional investors like endowments and pension plans.

As we return to an AFTER TAX world like we had in 1976, a flow through investment model will be highly favored.

Your insights are welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemails, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

[1] Annual returns for the FTSE NAREIT U.S. Real Estate Index


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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records Founder and chairman of CapitalWorks, he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CapitalWorks or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.

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