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The engine for such private equity plundering, as I would call it, comes from three tax changes made in the last 10 years. First, in 1998 the Government introduced taper relief on capital gains—I think quite reasonably, no doubt in the interests of promoting entrepreneurship—slashing capital gains tax for people
owning shares in their own companies or in unlisted businesses from 40 per cent. to just 10 per cent., provided that they owned the assets for at least 10 years. The real bonanza started in 2002, when the Government—amazingly—changed the rules again so that people only needed to own shares for two years to qualify for the hugely valuable 10 per cent. tax concession.
Then—no doubt the Government did not anticipate this—most companies with highly paid employees began setting up elaborate so-called share-based pay schemes designed to disguise income as capital gains. In 2003, the Government changed the rules yet again to require shares received as part of a pay package to be declared as income. The private equity gravy train nearly ground to a halt at that point. Unaccountably, however, the Government then exempted private equity from the new rules. So the gravy train rolls on, as a special deal for private equity.
Quite apart from the morality involved, that loophole is costing the Treasury a fortune. For example—this is the kind of thing that is being contemplated in respect of Sainsbury’s—from a mega-fund buyout of £10 billion, the private equity partners might expect to walk away after five or six years with up to £2.8 billion. If that were taxed as income, the Government would get £1.1 billion in tax; but if it were taxed as a capital gain, the effective tax rate might be as low as 7.5 per cent., which would amount to about £210 million. The Treasury would thus lose £900 million. Official figures show that the loophole is indeed costing the Treasury a fortune, with taper relief costing the Government £4.5 billion this year, up from £550 million in 1998.
Mr. David Gauke (South-West Hertfordshire) (Con): I note the right hon. Gentleman’s criticism of taper relief, which was introduced when he was still a member of the Government. Does he recognise that it does not apply just to private equity, or indeed just to equities as a whole? It can apply to, for instance, second homes.
Mr. Meacher: Of course I recognise that it has been limited. My point is that, although the Government properly imposed a limitation to prevent income from being disguised as shares, an exemption was then granted to private equity alone. I find that extraordinary, and I seek an explanation from my hon. Friend the Minister.
Two features of private equity firms stand out: the extravagant management fees and the annual “carry”—the share in profits. Researchers at Manchester university recently obtained the internal management accounts of one firm with up to £8 billion of funds under management. After five years, the 30 full partners expected to make between £25 million and £50 million each.
All this raises several questions. Does the performance of private equity funds justify the huge fees that are charged to investors? Does the elaborate financial engineering deserve its tax-deductible status, or are shareholder loans simply a device to reduce tax liabilities? As the shadow of private equity falls everywhere, is it making the gamut of private business hyper-short-termist, exacerbating still further what I
regard as the lethal weakness of British industry? Is private equity merely a force for the immense enrichment of a few at the expense particularly of the employees who are taken over, but also of the long-term future of the company itself? I believe that those questions need much wider, more serious and more careful debate.
I am the first to recognise that the private equity industry claims that it generates more jobs and faster economic growth than other sectors of the economy, but the annual economic impact survey of the British Venture Capital Association—which I looked up—does not show that at all. Most of the 1,400 companies surveyed are at the lower end of the industry, which, as I said at the beginning, is in a very different position. They have benefited from less than £10 million of investment from venture capital and growth investors. That is all very healthy, but only 3 per cent. of the sample in the latest edition received investments of more than £50 million—this is where public concern lies—and more than 60 per cent. of those respondents said that sales, profits and employment were the same or worse under private equity. More particularly, private equity firms always tell us about the jobs that they have allegedly created—that is entirely fair. What they do not tell us about is the jobs that they have destroyed, or the net employment impact. That is what we need to know.
Against that analysis, there are several actions that the Government need urgently to take, starting with the Budget on Wednesday. First, the taper relief loophole in capital gains tax and the special exemption granted specifically, and unaccountably, to private equity firms should be immediately ended. I shall look for that in the small print of the Red Book on Wednesday. Secondly, tax incentives should be “staircased” to encourage long-term investment of 10 years or more and to discourage in-and-out, rapid asset stripping. I believe that the phrase that is used in the trade is, “Flip it and spin it”. If it is, that is certainly to the bane of British industry. That needs to be strongly discouraged. We should have a tax incentives framework that strongly points in a different direction.
Thirdly, there needs to be much better transparency in private equity operations, not least a requirement for private equity firms to provide full quarterly reports in exactly the same way as publicly quoted companies.
Mr. David Drew (Stroud) (Lab/Co-op): Does my right hon. Friend agree that one of the problems arises where there is a carry-over from the existing ownership into the private equity firm? The private equity funding of that new firm also needs to be as transparent as possible. It does not have to be insider trading to make one question the way in which these relationships grow. Does he agree with that point?
Mr. Meacher:
I do. One of the incentives for a private equity takeover is to avoid the kind of accountability that has always been at the forefront of public liability companies. Any reduction in that is extremely dangerous not just for employees, but for other stakeholders and particularly for shareholders, who are often kept in the dark as much as employees. I am aware of the setting up of an internal industry working party on disclosure under the City of London
grandee, Sir David Walker. I welcome that as far as it goes. That is all very well, but it is no substitute for plc transparency, which is the minimum foundation for corporate accountability. In particular, there needs to be far greater transparency about the activities of some private equity firms—certainly not all, but some—in restructuring pre-existing company pension schemes, which may drastically affect workers’ pension rights in future.
Fourthly, private equity is at present largely self-regulating, which is not acceptable given the immense power that many major private equity-controlled firms now wield. I would like to quote briefly from Ernst and Young’s insolvency report last year, which states:
“the amount of credit that lenders are willing to extend on PE transactions has risen substantially. Lending limits are increasing, multiples are rising, transaction structures are being extended, and covenants are weakening”.
“In circumstances where many banks are involved in complex debt structures, due diligence is not as stringent. Banks are no longer in a position to sound the alarm if a company is too highly leveraged”.
That comes from an accounting company that has international prestige. It is carefully worded, but the Government should pay very careful attention to it.
Fifthly, and most important of all, there need to be far greater rights and protection for the interests of employees in the companies that are taken over. If it is not to be casino capitalism—not necessarily my words, but that is how this is often seen—where workers’ jobs and lives are gambled like so many counters on the gaming table, the promises made beforehand on jobs by private equity predators, because that is how they are seen, to gain control of companies should be statutorily enforceable. Private equity firms should be required beforehand to provide a public interest certificate or statement of the expected and intended impacts of the takeover on jobs, pay and terms and conditions of employees, as well as on debt, investment and the longer-term future of the target company. That statement should be contractually binding for a stated period, at least as far as the employment of the workers is concerned.
Those are just five key points—I could pick out a number of others, but they are the key ones—that the Government must urgently consider to allay the real concerns about current private equity operations. I look forward to their being addressed on Wednesday.
8.6 pm
Mr. Brooks Newmark (Braintree) (Con): I feel that this is a bit like round two of a debate that I had with the right hon. Member for Oldham, West and Royton (Mr. Meacher) on Radio Four's “Today in Parliament” programme last Friday. I was in the private equity industry for 14 years, and I declare an interest in this debate and draw hon. Members' attention to my entry in the Register of Members' Interests.
Listening to the right hon. Gentleman, I get a bit of the whiff of the 1970s. It brings me back to my teens. I can only assume that his campaign slogan for the Labour leadership will be “Back to the future with Michael Meacher”. The reality of private equity bears
no resemblance to the Beazer comic book analysis of private equity that, unfortunately, we have just heard.
I want to touch on several areas. On jobs, roughly one in six jobs in the private sector involves private equity. The right hon. Gentleman is absolutely right to be concerned about the relationship between private equity houses and the employees because they employ a lot of people, but jobs in firms controlled by private equity have grown much faster than in FTSE 250 or FTSE 100 companies.
Sales growth in private equity companies is roughly at 9 per cent. per annum. Again, the FTSE 100 companies grow at 7 per cent., FTSE 250 companies at 5 per cent. Again, exports by private equity-controlled firms grow at roughly 6 per cent. per annum, which is much faster than the national average of roughly 2 per cent.
Mr. Meacher: I referred to that in my speech. I commented on the fact that the British Venture Capital Association report, which is, I think, far and away the best evidence, indicates that what the hon. Gentleman said is true at the lower end of the market and for the smaller companies. However, when one looks at the smaller number of very large companies, that is not what the respondents are saying. The results are either the same or worse than under ordinary conditions. Private equity does not display the improvement that he claims.
Mr. Newmark: The BVCA analysis relates to all private equity companies. About 1,500 companies were invested in last year. Therefore, it covers the gamut; we are talking about private equity as a whole.
The final nail in the right hon. Gentleman’s argument is to do with the notion of asset stripping. The reality is that investment by private equity firms grows at about 18 per cent. per annum, compared with the national average of about 1 per cent. per annum. Therefore, jobs are up, sales are up, exports are up and investments are up; so much for the accusation of casino capitalism, to which the right hon. Gentleman alluded in his speech.
The private equity industry invested £11.5 billion in 1,500 companies in 2005 alone. This country has a 50 per cent. market share in Europe; that proportion is three times higher than that of our nearest competitor, which I believe is France. The City loves private equity because £3.3 billion in fees is paid to the financial services sector, the Treasury loves private equity because private equity firms pay £26 billion in taxes, and, most importantly, the pension funds love private equity because private equity firms deliver superior returns.
The question is: where does the problem lie? It does not lie in the preferential tax treatment. The Economic Secretary admitted in a speech at the London Business School that all companies pay taxes on a level playing field. There is no special treatment for private equity firms. The problem is not to do with asset stripping either, because, as I mentioned, investment by private equity firms is 18 times higher than the national average. The problem is also not to do with just a few people lining their pockets, as the right hon.
Gentleman implied. In my experience of private equity firms, the interests of the owners, the managers, the directors and the employees are aligned. Traditionally, most private equity firms have given share options to employees far deeper into the structure than have ordinary public companies or most companies in general. Therefore, when money is made, everybody is a winner, and when money is not made, no one makes money.
Mr. Gauke: My hon. Friend is making an important point. Does he agree that the following is the business position of a private equity fund: the intention is to acquire an investee company and to make money by disposing of it at a profit, and it will be able to do so only if it is disposing of a successful business that is making profits and providing a good service to its customers?
Mr. Newmark: My hon. Friend must be a mind reader, because that was precisely the point I was about to come on to.
We should consider what the pension funds do. They are among the biggest backers of private equity, and I assume that they would not back private equity if they felt that there was bad behaviour or poor governance, and if by backing PE they were not giving good returns to pensioners—in a trade union, for example, such as the GMB which I know invests in private equity. As my hon. Friend said, the reality is that private equity firms target underperforming assets and are a force for change, improving productivity and growth. Whether one is putting a company through the initial public offering—IPO—process or selling it on to somebody else, no one is going to buy it if they do not see continued opportunity for growth in it.
The key problem is to do with transparency. The right hon. Member for Oldham, West and Royton made an important point on that. When I began working in the private equity industry, buying a £25-million company was a big thing, but today there are billion-pound transactions—such as, potentially, those involving Sainsbury’s and Boots. Therefore, the impact on the economy, employees and on people in general who are customers of such businesses is much bigger. Private equity has grown from a cottage industry to a more mature industry, and more transparency is needed. That is why I welcome the initiative of the BVCA in setting up a working party under Sir David Walker. Issues to do with transparency and governance are important as the PE industry continues to mature.
I remind the right hon. Gentleman that the Prime Minister, the Chancellor and the Economic Secretary have all welcomed the benefits that private equity brings to UK plc. It seems that even the Secretary of State for Northern Ireland has undergone a Damascene conversion. I was interested to read that he said in a Financial Times article of 20 February 2007 that
“equity funds can be important...and it is essential that we have a tax system that enables the City to remain the pre-eminent financial centre of the world...a return to Old Left solutions of punitive taxation is not the answer. Nor is heavy regulation”.
I wonder whether the Economic Secretary might whisper a bit louder into the ear of the right hon. Gentleman.
Let me conclude by saying that I hope that the Economic Secretary will join me in applauding the achievements of the private equity industry, and that he will continue to safeguard Britain as a centre of excellence for private equity.
8.15 pm
The Economic Secretary to the Treasury (Ed Balls): I congratulate my right hon. Friend the Member for Oldham, West and Royton (Mr. Meacher) on securing this Adjournment debate. I wish to comment in detail on some of the issues that he has raised. Before I do so, let me also congratulate the hon. Member for Braintree (Mr. Newmark) on his elevation from the Back Benches to an advisory role on such issues. We look forward to receiving his contributions to the Finance Bill with relish, as always, in the coming months.
We have made great strides over the past decade in bringing about a stable economic environment to promote long-term decision making, and to promote investment, productivity, growth and job creation. We have taken important steps to make our economy more dynamic, to enhance competition and to deal with the challenges of globalisation. At the same time, our reforms to tackle short-termism and to promote long-term investment to deliver high and stable levels of growth and employment go beyond macro-economic policy; they also spread to employment, tax and industrial policy.
Unlike the hon. Member for Braintree, I take seriously the concerns expressed by my right hon. Friend. He has a track record of being concerned about the dangers of having a too short-termist approach to the economy. He knows, as do I, that there is a danger that high levels of unemployment and low levels of investment can arise if we do not tackle the sources of short-termism at root. As an employment Minister in 1997, he was involved in drawing up our new deal to take a more long-termist approach to employment policy. As Environment Minister, he pioneered the world’s first ever economy-wide greenhouse gas emissions trading scheme in 2002, which has set an agenda in terms of the environment for a long-termist and market-based approach for dealing with carbon emission. That now has cross-party support. In other areas that perhaps are less relevant to the economy, such as clean bathing water, he also has an important record in promoting long-term investment to deliver public policy goals. Therefore, as I said, I take his concerns seriously.
I should make it clear at this point that I wish my right hon. Friend well in his endeavours in the coming months, but I will not be one of the 44. That will come as no surprise to him.
In order to tackle the risks of short-termism and to promote a more long-term and dynamic approach to the economy, we have introduced a number of reforms since 1997. We have introduced reforms to competition policy, because a robust and tough independent competition policy is necessary for there to be a dynamic long-term economy. We have also introduced reforms to our tax system to try to encourage long-term investment, including reform to the capital gains tax regime to promote more long-term investment, which is one of the most important
reforms that we have introduced since 1997. We have promoted investment in science and innovation, and in education and skills. We have also introduced reforms in the area of corporate governance, following the reviews conducted by Paul Myners, Ron Sandler, Sir Derek Higgs and Sir Derek Morris, to help shareholders—and pension fund holders, the ultimate beneficiaries—in the deep liquid and dynamic capital markets to take a more long-term view of their role, given some of the concerns addressed in the reviews.
We start from a common view that short-termism has been a problem historically in our economy. It is important to find ways to address that and to have dynamism and competition, while taking a long-term view. At that point, however, I may part company from my right hon. Friend. The private equity debate has to be seen in the context of what is needed in economic policy to encourage a long-term view and promote long-term investment. Rather than taking a particular view of any particular form of ownership, the real issue for the economy, and for investors, savers and employees, is whether ownership structures support taking that long-term view.
I understand my right hon. Friend’s concern that private equity as a form of ownership may promote a short-term view. I am sure that he will agree that as with any form of ownership there will be private equity owners who are short-termist, but there is no intrinsic reason to believe that they are more likely to be short-termist than any other form of ownership. Therefore, there is no reason why the Government should take a view that private equity per se is bad rather than good for the economy. In fact, I agree with the general secretary of the TUC who acknowledged recently:
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