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Your Money > Investments Articles > Private equity - what's all the fuss about?
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By Sarah Modlock Apparently, some people are really, really rich. And there's a rumour that us mere mortals pay more tax than they do. If the rumblings surrounding private equity have made your ears prick up in recent weeks then you could be forgiven for thinking What is private equity? Put simply, private equity is money which is gathered together to invest in a certain way. A private equity company might combine its partners' own money together with some raised through pooling the cash of a group of investors. The money is used to buy companies which could be made more profitable. Usually, these companies are listed on the stock exchange and the private equity buyers remove them from the stock exchange while they are changing the business. In exchange for the money they put in, private equity investors receive a stake in the company and, as shareholders, the investors' returns are dependent on the growth and profitability of the business. The idea is that they then sell the revamped company or re-list it on the stock exchange and everyone involved in the private equity buy-out makes a healthy profit, often in a relatively short period of time. Why is it topical now? You may wonder why private equity has been in the news so much. This is partly to do with some high profile private equity buy-outs in the UK, where household names have been taken into private ownership. You may have heard about the takeovers of Alliance Boots (the huge pharmacy and beauty group which includes Boots the chemist), the AA, Birds Eye, Halfords and Kwik Fit. But even bigger headlines have been created from the changes which have been made at some of these firms, with critics saying that private equity firms are only interested in asset-stripping companies and walking away. It's certainly true that some bought-out companies have seen significant changes and hundreds of job losses. In some cases, customers report dropping standards of service. There are also concerns that some private equity firms use too much debt to finance their deals. What's all this about taxes? Tax is never a sexy subject until you hear that someone is not paying their fair share. And this is one of the debates which has brought private equity into the news again. Private equity executives pay taxes on their earnings and bonuses in the same way as anyone else. But the bulk of their earnings comes from carried interest - the 20% slice of profits they can claim once they have paid back their investors. This money is classed as a capital gain, and as such is subject to a tapering tax level of 10%. Critics say it should be charged at a normal tax rate. In some cases, it is possible for executives pay as little as 5% tax after they have written off loss-making investments against tax. One private equity boss, Nicholas Ferguson of SVG Capital admitted recently that people who run and invest in private equity paid tax at a lower rate than their office cleaners. Is anyone keeping an eye on all this? Amid ongoing attention from industry and the media, there are calls for the private equity sector to make their work more transparent and for the tax regime to be examined. In June, the powerful cross-party Treasury Select Committee summoned the bosses of the biggest private equity firms, including Permira, Blackstone and 3i, to answer questions about the way they do business and pay tax. During an hour-long grilling, three officials of the British Private Equity and Venture Capital Association (BVCA) engaged in fierce exchanges with MPs over the extent and nature of tax advantages and accusations that the industry was failing to talk to workers and trade unions when such firms closed factories and cut jobs. Jeremy Hand, the BVCA's vice-chairman replied that the tax regime stimulated enterprise and entrepreneurship; it had made the UK the envy of other countries, and many were copying the system. Private equity has invested £80bn in around 29,500 firms since 1983 and there is a concern that this investment will disappear if the tax system is changed. But unions accuse the firms of profiteering at the expense of workers' jobs, pensions, and benefits. They also say private equity fails to disclose its activities in the same way as publicly listed companies, and lacks transparency. Will anything change? Some things are changing already. The industry is establishing a voluntary code aimed at improving disclosure and transparency and it is likely that the tax regime for private equity will be reviewed, although this will affect only a handful of executives (something like 40 out of 200) who remain based in the UK. The others base their finances offshore and more are expected to follow if the tax breaks are changed. Referring to private equity in his speech to the GMB union congress in Brighton in June, Gordon Brown told delegates: "We will make sure that there is justice and equity in the treatment of the tax arrangements in that area." Following the Select Committee meeting, the BVCA's head, Peter Linthwaite, resigned amid criticism that he had put in a weak performance in front of the Committee. So is private equity a bad thing? In many ways, it's a very good thing. It has been praised by Tony Blair, Gordon Brown and Shadow Chancellor George Osborne as providing a great contribution to the UK economy. In March, Gordon Brown told parliament that he wanted to "congratulate" the private equity industry for the "creation of more jobs at a faster rate". "There is much evidence that the rate of job creation through private equity has been high," the Chancellor said, adding: "We've got to distinguish between companies that are long-termist and short-termist." The BCVA says that private equity-backed companies have been shown to grow faster than other types of companies and says that this is made possible by the provision of a combination of capital and experienced personal input from private equity executives, which sets it apart from other forms of finance. It could be that a little more accountability is what is needed to ensure that the benefits of private equity are not suffocated by additional red tape and regulation nor overshadowed by the potential for asset-stripping and profiteering. Useful links: |
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