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Not-so-private equity

Robert Peston | 12:00 UK time, Tuesday, 17 July 2007

Sir David Walker was recruited by the private-equity industry to assess whether it was communicating adequately with the outside world. He knew the answer before the off – since for most partners in private equity firms the “private” bit of their moniker is a way of life.

David WalkerWalker says such secrecy is no longer appropriate. No surprise there. The Treasury has made not-very-veiled threats that if private equity firms don’t do a better job of telling their employees and other interested parties (including largely ill-informed politicians) what they’re up to, they could find themselves compelled to do so.

Also, there is a semi-respectable intellectual case for greater disclosure, which is that they now control such a big and rising share of the British economy (they are responsible for an estimated 8 per cent of UK private-sector employment) that there is a public-interest case for having clearer oversight of their activities.

Walker himself – as someone who believes that private equity spurs productivity improvements and economic growth – hopes that harvesting more robust data on private equity will turn out to be good for the firms.

He is convinced that analysis based on reliable information – which he acknowledges is in short supply – would put paid to criticisms that private equity is largely a “bubble” phenomenon created by cheap credit markets and rising share prices.

He believes that private equity will be able to demonstrate that it creates wealth to a large extent through superior operational management of companies.

That said, he does acknowledge that the capital structure of private-equity owned businesses is probably superior to that of many public companies.

Or, to put it another way, he is bemused that listed businesses haven’t followed the lead of private-equity-owned ones by borrowing more and borrowing in a more sophisticated way.

For me, therefore, the most welcome of his recommendations are those that should allow the current heated and emotional debate about private equity to be replaced by one that actually has access to proper facts.

So, for example, Walker wants private-equity firms to disclose by category the source of their equity funding – which will show that any superior returns they make are distributed largely to overseas investors, rather than to British pension funds.

He also urges that private-equity firms publish a breakdown of their returns to show what proportion of their profits comes simply from riding on the back of rising stock markets, what share comes from financial engineering and what part comes from genuine productivity and trading improvements in the businesses they own.

Another proposal is that the private-equity partnerships should publish an annual account of their respective investment philosophies and how they oversee and direct companies in their portfolios.

Finally he wants private-equity owned businesses to behave a little more like public companies by publishing proper annual reports of their financial and operational progress within four months of the year-end and shorter six-monthly statements.

Critics of the industry will say this is all motherhood and apple pie – and that Walker is merely deflecting from more important debates about how little tax private equity pays and its impact on employment.

Except that these debates are less informed than they might be, in the absence of the kind of information which Walker’s proposals should yield.

So one reasonable concern is that some private-equity firms will ignore whatever code-of-practice emerges from Walker’s review, because they will view it as burdensome and intrusive.

And although the media, politicians and trade unionists may name and shame them, these firms won’t give a stuff, so long as they continue to receive oodles of cash from their overseas backers.

Comments   Post your comment

  • 1.
  • At 01:30 PM on 17 Jul 2007,
  • Simon wrote:

Rober said: "So, for example, Walker wants private-equity firms to disclose by category the source of their equity funding – which will show that any superior returns they make are distributed largely to overseas investors, rather than to British pension funds."

Well, this is an issue that can't be considered in isolation:
- What percentage of private equity proceeds from overseas do British pension funds get?
- What about UK private equity firms operating overseas and bringing these profits back to the UK?
- For that matter, what about the profits going to foreign owners of UK shares?

And as for tax and leverage:
- Profits that are not taxed inside the firm are taxed in the hands of bondholders.
- We can't argue that profits (in the form of dividends, coupons, or capital growth) are being taken overseas thus depriving HMT of tax revenue without considering the taxation of UK entities earning their income overseas but being taxed here.

As soon as you focus on one issue within the subject of PE you find soundbite material but not sound material to bite into. Most things have to be considered in a decidedly macroeconomic way.

  • 2.
  • At 02:08 PM on 17 Jul 2007,
  • Nat wrote:

As I understand, the original idea of private equity was to encourage equity groups to invest in small to medium businesses, and thus helping more credit and money available to start ups and innovative companies.
And thats why there is tax cuts, and tax breaks for private equities if they hold the stock for certain number of years.

But these days, private equity groups are more interested in taking over high street banks with billions of money, not into investing in SMEs, and have totally defeated the original idea.

I dont understand, how taking over of Boots by private equity groups is going to help the economy anyway. All they are going to do is, make use of the tax breaks, steal the money, then strip off the assets, award the directors huge amount of bonuses, then run away, making Boots bankrupt in few years time!

Private Equities are the evil of capitalist model. Unless the govt. tightens the control and monitor the motives of the private equity groups, we are likely to see more and more bankrupts in near future!

  • 3.
  • At 03:36 PM on 17 Jul 2007,
  • Neil wrote:

Roll-on a less polarised debate! There is no way that PE is a bad thing per se, it is a good thing. However, there are legitimate concerns that a lot of recent activity is a result of a balance sheet arbitrage with little care for the sustainability of this business model.

The performance fee embedded within private equity funds means that investors are gifting the managers are free call option on the businesses they buy, which they would be silly not to try and capitalise on – the quicker the better.

The long-term losers though when, as is highly likely, the current easy financial conditions disappear, will not just be the investors, but the economy as a whole as numerous overleveraged businesses go into default and bankrupcty.

  • 4.
  • At 03:37 PM on 17 Jul 2007,
  • not_me wrote:

"That said, he does acknowledge that the capital structure of private-equity owned businesses is probably superior to that of many public companies.
Or, to put it another way, he is bemused that listed businesses haven’t followed the lead of private-equity-owned ones by borrowing more and borrowing in a more sophisticated way."

I'm not an economist so this quote is why I read this blog: it just says simple stuff simply rather than obscuring it in layers of cleverness. I've always suspected there's less than there often appears so, like techies (I'm one), it often gets deliberately fluffed up to look mysterious.
Continue the defluffing.

  • 5.
  • At 03:38 PM on 17 Jul 2007,
  • Chris S wrote:

Simon (#1), I agree with most of your points, but not sure you cover all the tax ones. One point (that I don't agree with it) is that equity is doubly taxed, both inside the company and as dividends, while debt is taxed only outside. This has been used to paint higher gearing as a way of paying less tax. Which, of course, is the net effect on the Treasury's coffers, but this saving does not go to the PE firm, but to their financers, and is long established in the different cost of debt and equity finance.

The other (much bigger) point is the tapered tax relief for start-up companies, whereby simply buying a large business in a rising stock-market and sitting on it for two years lets you get away with paying 10% capital gains tax. This one is a little bit more suspect, in my opinion.

I am not convinced by forcing Private Equities to reveal source of their funding and future strategy for any buyout we doing any favour to anybody apart from Unions and ill informed politician - trying to reaping benefits of venerable staff.

see private equities are buying ill managed companies not cash cow.

  • 7.
  • At 04:37 PM on 17 Jul 2007,
  • Nat wrote:

To "Free Market Research" (Post 6),

"Private equities are buying ill managed companies"

oh, really? Thats why they bought Boots? And thats why they repeatedly trying to take over Sainsburys?

And after buying ill managed companies, what exactly they do? They get the tax breaks, increase the debt load of the company, kill the company pension (or steal the pension pot which is already there with promise of returning more money), default on employee wages, default on payments to suppliers then declare bankrupt.

If an ill-managed company is worth of £100m at the time of purchase by private equities, in 3 years time, the company will declare complete bankruptcy with debt of over £400m to the suppliers, and another £400m deficit in pensions and employee wages, and will be sold for just £1.

But where did all the money go? oh, its a private equity, so you can't ask about it, but it is very likely that the companies directors are richer by the tune of £800m. (numbers do add up!).

Private equities is a scam, so is the Carbon Trading. I can't really believe the govt. is dare enough to run this scam!

  • 8.
  • At 05:17 PM on 17 Jul 2007,
  • Simon wrote:

Chris (#5) commented on tax.

Yes, debt interest is tax deductible, but note that investors require a higher (after debt interest) "return on equity" for a more leveraged company - as evidenced by PE houses having higher hurdle rates of return for their investments than capital markets investors. This has all sorts of ramifications: a partial compensation for the loss of tax on profit that goes to pay debt interest, a motivation for greater efficiency which may improve the efficiency of the firm's industry as a whole (improving total tax take), etc etc.

You lift the lid on tax and it's a writhing mass of contrasting second order effects.

As for the much debated taper relief issue: it's one of those things like "if you raised the income tax rate, would you reduce or increase total income tax takings?". It's not clear.

Clearly the gvt has decided that encouraging "venture capital" (in the broadest sense of the phrase) is good for the economy as a whole, so in the medium term is good for gvt coffers too. One thing is sure. If they did away with the taper relief, far fewer deals would meet the hurdle rate in the UK so much PE money would flow elsewhere with an adverse impact on tax revenues. Would it offset the increased rate of tax on capital gains? I don't know, but it certainly would reduce economic activity.

  • 9.
  • At 06:47 PM on 17 Jul 2007,
  • Angie wrote:

"So, for example, Walker wants private-equity firms to disclose by category the source of their equity funding – which will show that any superior returns they make are distributed largely to overseas investors, rather than to British pension funds"

If this is something that walker is recommending should be disclosed that mean that the information is not yet available. If it is not yet available how does Peston know what it will show? Or is this a case of the journo making up the sources?

If this does show what Peston thinks then the people who run the British pension funds are even bigger idiots than anyone has previously assumed. PE has been a stellar asset class and they have been underinvested!

PE executives should go to Monaco. I see in the Sunday Times that Prince Albert wants them there. No tax I see of any kind whether domiciled or not. why bother with the jealous politicos and journos in London?

  • 10.
  • At 11:56 PM on 17 Jul 2007,
  • Mike Hedges wrote:

Lots of good points covered in the posts so far, but for me the real shock was to find out (ref SAGA and the AA) that the Private Equity leveraging was apparently so high that not only did the companies under ownership of the PE people pay no CT, they actually were able to claim millions in tax refunds from the Treasury - i.e. from us. Allowing interest payments against profits for tax purposes is one thing, but pushing the amount of debt and hence that relief on interest into refund territory (at least in the current year - perhaps carry forward might be tolerable) is a huge step too far. At the moment, the PE guys must be laughing up their sleeves at us all.

  • 11.
  • At 03:25 AM on 18 Jul 2007,
  • Nicholas A wrote:

"So, for example, Walker wants private-equity firms to disclose by category the source of their equity funding – which will show that any superior returns they make are distributed largely to overseas investors, rather than to British pension funds."

Will it? And if so, what will it mean? It would be interesting to know what percentage of listed shares are held by non-UK investors - and also the percentage of UK institutional funds that are invested outside the UK.

  • 12.
  • At 07:46 AM on 18 Jul 2007,
  • Patrick wrote:

"so long as they continue to receive oodles of cash from their overseas backers."

Well, Robert, until the source of their funding is revealed, how can you be sure that their backers are "overseas" ? And, as others have highlighted above, does it really matter ?

No-one at the BBC cares when a foreigner pumps hundreds of millions of pounds into turning Chelsea football club around but as soon as what may or may not be foreign investors start to take rather more calculated and intelligent investment decisions, it is portrayed as rather more suspect...

Only a percentage of the PE market is directed solely towards yields and distributions (and quite often these are the same funds that pension companies choose - what irony!).

So surely it is in the interest of the economy to cultivate the PE involvement in long-term company performance by offering them tax breaks. Using Marks & Sparks and Somerfield as examples, PE involvement over the last few years saw drastic increases in both performance and stock value.

Take the tax breaks away, and surely you invite them to take the quick buck by asset stripping?

  • 14.
  • At 02:58 PM on 18 Jul 2007,
  • Peter Bench wrote:

It is a sad reflection of both the standard of BBC journalism and general economic education to read so many of these posts. Mr Peston makes any number of unproven allegations in his piece and the other correspondents on here seem to think that all capitalist business activity is cut-throat and venal. Oh, and food for thought, why is nobody suggesting that all our private/family owned companies should be subject to some sort of public review? I'll tell you why - because it ain't nobodys business but theirs.

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