Five Kinds of Private Equity—And How Your Client May Be Able to Contribute Them to Charity
When your clients work in private equity (PE), they are likely to have a portfolio full of complex—and often highly appreciated—assets. In 2021, we saw the potential for growth in PE, as global AUM by PE funds reached a record $6.3 trillion, according to McKinsey’s Private Markets Annual Review.
As a financial advisor, you know that appreciated long-term assets are among the most favorable gifts to give to charity. When your client is able to contribute those assets directly to charity rather than selling and making a donation from the proceeds, they may be eligible for a fair market value (FMV) deduction and to avoid capital gains tax. This strategy can preserve greater value for future grantmaking.
What you may not know is that with the help of charitable experts like those at National Philanthropic Trust, you and your client can navigate the holding requirements and tax considerations associated with private equity contributions to make charitable use of their portfolio.
There are, of course, complexities associated with private equity gifts. In this post, we’ll first examine the different types of private equity holdings and their ability to be used as charitable contributions—then we’ll take a look at how clients like yours can make it happen at NPT.
Types of Private Equity Gifts
- Limited Partnership (LP) Interests in a PE Fund: If your client holds an LP interest in the private equity fund, they may be able to contribute that interest to a DAF. Gifts of this type are easiest if the LP interest has no open or unfunded capital commitments.
- LP/LLC Interest in a “Carryco” (Carried Interest): If your client is associated with the investment team managing the private equity fund and holds an interest in the entity entitled to receive the carried interest (the “carryco”), they may be able to contribute that interest to charity—so long as they give an undivided interest. NPT will review documentation related to your client’s ability to transfer the interest, and will need to determine whether there are any clawback obligations that could affect NPT’s ability to accept the gift.
- Interest in the Management Company: If your client is affiliated with the management company overseeing the day-to-day management of a private equity fund, they may wish to explore contributing their interest in that company. Unfortunately, this interest is usually subject to stringent restrictions on transferability. Additionally, income associated with the interest is taxable to the DAF, which reduces the balance available for your client’s grantmaking, making it the least favorable type of gift.
- Interest in a Co-Investment Vehicle: If your client is an investor in an entity that is invested in a portfolio company of the private equity fund, alongside but separately from the PE fund’s investment, they may be able to contribute their interests in that entity.
- Portfolio Company Stock: If your client has received as compensation an in-kind distribution of shares of one of the private equity fund’s portfolio companies—which usually takes place after a company goes public—they can contribute those shares to a DAF. Portfolio company stock is the most common type of private equity gift, and the least complex to process.
How NPT Makes it Work: A Case Study
A donor we’ll call Arjun is a principal of the private equity firm XYZ Capital. He approached NPT because his fund had completed the investment stage and was entering the final phase of its life cycle. Knowing his limited partnership interest was about to yield liquidity, Arjun wanted to explore his options for charitable impact, to prepare for the windfall that was coming his way.
Arjun had been considering different charitable vehicles and was looking for an option that did not require the time and energy that operating a private foundation would demand. But when he heard that gifts of LP interests to a DAF may be eligible for a full fair market value (FMV) deduction, rather than the cost-basis deduction that the same gift to a private foundation would yield, he started inquiring more seriously about opening a donor-advised fund. And since his initial investment in the private equity fund had grown twentyfold over the course of its life cycle, he was motivated to find a philanthropic vehicle to move forward with his charitable aspirations.
Ultimately, NPT worked with Arjun and his financial advisor to collect and review all documentation related to Arjun’s ownership and the transferability of the LP interest, which included the LP agreement and private placement memorandum, among others. During the five weeks it took NPT to complete operational due diligence, Arjun opened his DAF online; he talked with his family about designing a Legacy Plan that suited their long-term goals, and he made a cash contribution to cover charitable administrative fees and short-term grantmaking.
Once due diligence was completed, the donor facilitated the transfer of his LP interests. In contributing $2 million in LP interests to the DAF, he was able to avoid $452,200 in capital gains tax (assuming his initial investment was $100,000, with a 20% capital gains rate and a 3.8% Medicaid surtax) and save $740,000 on his income tax (assuming a 37% marginal income rate). Most importantly, after NPT liquidated the interest, Arjun was able to recommend grants to an organization providing access to clean water and health services for remote villages in Southeast Asia.
No matter how complex the asset, NPT’s charitable experts are willing and ready to help you and your client explore whether it can be used for philanthropic purposes. If you or your client are ready to discuss a gift of private equity, contact our team at firstname.lastname@example.org.
NPT does not provide legal or tax advice. This blog post is for informational purposes only and is not intended to be, and shall not be relied upon as, legal or tax advice. The applicability of information contained here may vary depending on individual circumstances.