Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Prospect Capital Corporation's Smart Tax Strategy

Business Development Companies like Prospect Capital Corporation (NASDAQ: PSEC  ) can own controlled companies. But how they structure these buyouts has huge tax implications. Debt can help reduce taxes. Equity, on the other hand, provides tax-efficiency for the shareholder base when it comes to capital gains.

In the following video, Motley Fool Financials Bureau Chief David Hanson and Fool contributor Jordan Wathen ask Grier Eliasek, Prospect Capital's president and COO, Grier Eliasek, about the company's tax strategy. Additionally, the Fools seek some rationale behind Prospect Capital's heavy use of debt investments.

Risk-free for 30 days: The Motley Fool's flagship service
Tom and David Gardner founded The Motley Fool over 20 years ago with the goal of helping the world invest...better. Their flagship service, Stock Advisor, has helped thousands of investors take control of their financial lives and beat the market. Click here to sign up today.

A transcript follows the video. 

Wathen: Then finally, just to round it out here with a quick question on deal structuring -- is there advantage to structuring these buyouts with more equity to generate capital gains, or is there advantage to structuring it with more debt?

I know historically you have structured a lot of these investments with more debt than equity, and I was just curious to hear your take on that.

Eliasek: When we buy a company in a one-stop manner, where we supply a majority of the equity and debt, our desire is to do so tax efficiently. We do not want to under-leverage these businesses to result in tax leakage for shareholders.

We also want to be prudent about how much we pay for these businesses, so we can continue to generate an attractive yield for our investors. Many of our buyouts have been completed at only around 5x cash flow, which is not much more than a lending multiple in today's market. Ideally, we therefore get the equity for free, or close to free, which gives us upside in the business.

From an investor measurement perspective, our observation is that public company investors strongly prefer recurring income streams to lumpy capital gains for their base return, so we expect to continue to structure our control deals in this manner.

If any of these companies should do tremendously well -- and we are evaluating multiple companies in our book today for potential exit -- we would of course also generate a tax-efficient capital gain for our investors, so we like to have our cake and eat it, too.

Wathen: Right, so rather than have the portfolio company pay taxes, you can insert enough debt to where you take the income out through the debt, without having it come through the equity? You're saying you basically minimize taxes at the portfolio company level?

Eliasek: Correct. Also, we're able to pledge those types of loans to our credit facility, get to borrow against them; a number of benefits.

Key in all this is not to overpay for a company. If you overpay for a company, whatever amount of debt you might slap on it, if the company can't service the debt -- and that's pretty clear; we put companies on non-accrual if it can't pay its contracted obligations within 60 days -- there's really no way of getting around it.

If we stick to the rules of not overpaying the companies that we're buying, and not over levering the companies that we're lending money to, that we're not buying, then we're going to be in very good shape, indeed.

Hanson: I've got one more question for you, and then we'll finish up here. If you were investing in one soccer team to win the World Cup, what are you picking right now?

Eliasek: Well, I'm an American, right?

Hanson: That's the right answer!

Eliasek: I'm going to pick with my heart, rather than my head. Go Team U.S.A.!

Hanson: All right, that's what we like to hear. Grier, we really appreciate you taking the time to talk with us today -- really insightful stuff -- so thank you very much.

Eliasek: David and Jordan, I really appreciate your time and hospitality on this show. Terrific, thank you.

Hanson: Thanks.

Wathen: Thanks.

Read/Post Comments (0) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3044979, ~/Articles/ArticleHandler.aspx, 8/28/2015 6:35:18 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Jordan Wathen

"The liabilities are always 100 percent good. It’s the assets you have to worry about." - Charlie Munger

Today's Market

updated Moments ago Sponsored by:
DOW 16,643.01 -11.76 -0.07%
S&P 500 1,988.87 1.21 0.06%
NASD 4,828.33 15.62 0.32%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/28/2015 4:00 PM
PSEC $7.71 Up +0.21 +2.80%
Prospect Capital C… CAPS Rating: ****