Select Committee on Treasury Written Evidence

Memorandum submitted by GMB


  This submission is made by the GMB, the third largest trade union in the United Kingdom. We have already had considerable experience of dealing with the impact on workers in relation to the private equity industry, particularly as regards the Automobile Association.

  Dr. Ian Clark from Birmingham Business School at Birmingham University has also ably assisted us. Dr. Clark has written extensively on industrial relations and economic performance, and is currently researching the impact of private equity firms in the marketplace.

  According to the private equity industry's own figures it currently employs 1.2 million people in Britain, around twenty percent of the people currently working in the private sector.

  Figures from Financial Services London (a private sector organisation) show that the largest growth in private equity funding has been in Europe, predominantly in the United Kingdom. The British Venture Capital Association (BVCA) states that there was £11.7 billion of private equity funding invested in Europe in 2005, whilst venture capital funding (the investment in new businesses) decreased. The BVCA also acknowledges that 50% of all private equity activity in Europe is in the United Kingdom.

  Private equity funding can be characterised as a fund put together by a firm who seek out existing businesses which meet their profile, buy that business and take it into private sector ownership, where they reorganise the company and re-engineer the company finances. This should be differentiated from venture capital funding where investors invest funds in a start up or existing company but do not take over the management and organisation of that company. The BVCA often talks about Private Equity Fund's (PEF'S) and Venture Capital funds (VC's) together, as though they are the same thing. This is because VC's often have more positive statistical outcomes in terms of wealth creation, tax contribution and job stability. By mixing PEF's and VC's together, the BVCA seeks to conceal the more negative statistics regarding PEF's.

  The GMB is not seeking to raise concerns about the VC industry, but to focus in on PEF's. We would ask that the Committee requires the BVCA to break out the statistics they are reporting, into the distinct numbers related to PEF's, not an amalgamation with irrelevant VC statistics.

  GMB would also respectfully ask that the BVCA make their research available for independent analysis and evaluation. In gathering the evidence for this submission, GMB was frequently informed by academic experts in the business and industrial relations field that the BVCA and PEF's will not allow any independent scrutiny of their economic claims, suggesting they do not believe it will stand up to such an evaluation.

  There are many reasons for the massive growth of the UK private equity sector, amongst them the lack of regulation as compared to listed companies, the many tax advantages they are offered particularly in relation to debt repayment, the fact that there are many buoyant asset rich/cash poor companies in Britain, and a perception that private equity funds will create leaner more successful companies, and are good for business and the economy.


  Private Equity Firms (PEF) currently operate within a completely self-regulating environment. They have their own industry organisation; the BVCA, which exists primarily to promote the interests of the industry. The Financial Services Authority (FSA) is interested in PEF's, but has no regulatory control or powers.

  We argue that PEF's have a huge impact on the British economy, both positive and negative. Everyone is in agreement that the UK currently provides the most PEF -friendly environment in Europe, and this has encouraged a massive growth in the funds that choose to invest in Britain.

  The combination of PEF orientated tax breaks and the lack of any regulation has encouraged PEF's to invest £11.7 billion in the UK in 2005 (up from £9.7 billion in 2004).

In 2006 the market grew again though it is difficult to ascertain exact figures.

  The BVCA promote the view that this unregulated and expanding type of investment always has a positive impact on the economy. They talk about job creation and the benefit of PEF's taking over British companies, and contributing to the Treasury.

  However the lack of much independent research or a regulatory structure means that the negative impact of PEF has not been evaluated.

  Ironically it is the FSA that first publicly raised the alarm about the lack of regulation of PEF in their consultation document published in November 2006—"Private Equity—A discussion of risk and the regulatory environment". Whilst they opened their document by stating that the current regulatory environment was "proportionate", they went on to acknowledge that our regulatory environment was "substantially different" to all other countries. The document then goes into a detailed analysis of the numerous potential problems, which the FSA can see looming with PEF's.

  The FSA has an interest in the unchecked growth of PEF, because as more companies go into private ownership, the value of the stock market declines. The UK equity market capitalisation shrank by a net £46.9 billion in the first half of 2006, and has not grown since the last quarter of 2004 according to the FSA. No attempt has been made to value the PE owned sector.

  Whilst we will not go into a detailed analysis of the FSA's consultation paper here, they clearly identified that the risks of excessive leverage largely unchecked by the market and the lack of transparency in the type of investments being made, the complex layers of debt, diluted risk analysis and the risks of interest rate rises causing major defaults in the PEF market with subsequent collapse of companies, are all significant and growing risks to the British economy.

  As a Trade Union, we are extremely concerned about the way that PEF's operate particularly in the MBI (Management Buy In by external PEF's) (as opposed to MBO—Management Buy out, where existing management raise funding to buy their own company) arena. The evidence available shows that MBI's lead to massive restructuring of companies to financially re-engineer them. We believe the prime skill of PEF's is not related to growing companies and jobs but in the area of selling assets, and manipulating cash and assets in order to leverage the companies, and then redistribute these funds from the company into the hands of the investors. Our experience is that this leads to significant job cuts, and the eventual sale of the company in a far less stable economic state than it was before the PEF became involved.

  The Work Foundation carried out a detailed evaluation of 1350 PEF MBI's between 1999 and 2004, and saw that despite assertions to the contrary by the industry, jobs are cut by 18% after three years. The BVCA publishes figures, which maintain that there is job growth. This is because they use the figures for MBO's and MBI's together. In an MBO, the existing management raises funding from Venture Capitalists to buy their own company, and statistics show in those circumstances, that there will be a positive increase in jobs. The fact that the BVCA records these figures together is a disingenuous attempt to conceal the fact that PEF MBI's mean job cuts.

  We believe that there needs to be oversight of the industry and regulation, which looks at the social and economic impact they have on the country. We do not support the view that the redistribution of a large proportion of UK companies (19% of British companies according to BVCA) wealth into the hands of a few wealthy investors, often based offshore, leaving companies heavily in debt is in the best long term interests of the UK economy.

  PEF's currently do not have to provide any insight into the way they are structured, nor do they have to explain their intentions when buying into a UK company or bear any responsibility for the economic and social consequences after they have sold the company.

  BVCA argues that if the Government regulates the PEF industry then PEF's will leave Britain for more friendly investment territory. This is patently untrue, as almost all countries in Europe except Britain are already regulating PEF's, so there is not going to be a "better" site for them to invest. Britain is full of asset rich companies, which will continue to attract private equity investment.

  The lack of regulation also means that there is no consideration of the impact of PEF's on industrial relations and Trade Unions. In particular we have concerns about the impact an unregulated PEF can have on collective bargaining agreements. When a PEF takes over a company the ownership, structure and status of the firm changes, this allows the PEF to ignore existing arrangements and act in any way they choose, destabilising the terms and conditions of the workforce.

In the case of the AA, the PEF's involved established and supported their own staff association whilst derecognising the Union at the same time. Company management made it plain which organisation they would prefer staff to join by offering practical support for the staff association and discontinuing the deduction of Union fees from staff pay. After the Union had been derecognised, 3500 staff were identified and informed that they could elect to leave their jobs with a limited financial package or be heavily performance managed with the implication that they would lose their jobs for poor performance with no package.

These are the actions of an unregulated sector.


  All parties seem to agree that an excessive amount of investment is now flowing into PEF's because they produce such good returns for their own investors. As a result of the huge amounts involved, banks, which would traditionally have had a "hands on" approach to risk management of the amounts they are lending, are no longer able to regulate. They are usually only one bank lender amongst many competing for lucrative PEF business. PEFs layer debt onto the companies they buy into by selling off assets or leveraging them to raise funds. This means that there are usually many banks involved with the lending, and they are not aware of the overall debt picture of the company when they lend funds.

  The BVCA consistently refuses to be drawn into a discussion on the inevitable negative impact of a rise in interest rates on excessively leveraged companies. They always state that they will only report on the situation as it stands today, as if it is unreasonable to consider the massive impact on the UK economy, when companies cannot meet their liabilities due to over leveraging. We would argue that this is disingenuous. Many economic organisations are sounding the alarm about private equity and the BVCA's refusal to discuss one of the central concerns about PEF's, reflects their implicit acknowledgement that that situation would be of very serious concern to a government trying to manage the national economy.

  An important factor is that different banks become involved over time preventing any single bank having an overall picture of the debt that the company is carrying. For instance the PEF will take out primary debt in order to facilitate buying the company.

  For instance when purchasing the Automobile Association (AA), the PEF's—Permira and Blackstone—raised a five hundred million pound loan.

  Once they have taken over the company the PEF then looks for ways of reducing overheads and leveraging assets to make the company look more profitable and to either sell assets or leverage them in order to borrow against the company assets.

  In the case of the AA the cost of this was 3,500 jobs and significant changes to remaining worker terms and conditions, plus restructuring of the pension fund. It cannot be good for the economy when workers are losing jobs, or working longer hours for reduced pay.

  PEF's then take on secondary and tertiary layers of debt, each bank lending against specific assets, and under differing terms, often structured so that repayments do not become due for several years. In this way the company continues to appear profitable, whilst the debt load is increasing, with each bank only having part of the overall debt picture.

  In order to find profits for the Fund, the PEF must restructure the company both financially and organisationally. The priority of the fund is to find ways to fund debt and pay back cash to their investors. PEF's claim that they are better managers who benefit society by boosting employment and profitability. The lack of transparency in the industry makes it difficult to evaluate these claims independently, and they are made almost entirely by the BVCA and the industry itself.

  To satisfy investors and meet debt requirements, PEF's must inevitably cut costs in the business. Whilst it is true that they tend to reward top executives, a downward pressure on pay reduces costs, pension provision, job security and redundancy provisions for ordinary workers.

  We have particular concerns about the lack of protections for pension funds. PEF's take decisions in relation to the reorganisation of pension funds, and using them to secure debt. The protection of the pension fund as part of the benefits of employment rather than as an asset to secure debt is of key importance, particularly in the event that the economy turns downwards.

  Even the FSA acknowledges that there is now so much leverage that any downward shift in the economy or rise in interest rates will cause significant default and the collapse of companies. PEF's will not be paying for this; it will be company employees, company pensioners and taxpayers picking up the social and economic costs.

  In April 2007 the International Monetary Fund made an unprecedented warning in it's bi-monthly Global Financial Stability Report that companies being snapped up by private equity firms are increasingly "fragile" because of excessive leverage.

  They expressed the view that deals are getting bigger and private equity players are becoming less discriminating in what they buy because there are fewer suitable targets.

  They reported that;

    "Takeover activity is taking place against a benign backdrop of continued global growth, low real interest rates, high corporate profitability, and low volatility. If just one of these factors changes, deals that looked promising in a benign environment could suddenly appear much less attractive."


  The BVCA states repeatedly that PEF's are treated no differently than other types of companies and investors. We believe that PEF's have significant tax advantages, and that seeking out these advantages is a significant part of what makes them profitable to their investors.

  BVCA talks about the significant contribution to the Treasury by PEF's, they do not discuss the fact that most of the money made by PEF's benefits from significant tax advantages, and goes offshore to protected Trusts. Part of the attraction of PEF's to investors is their ability to pay the smallest amount of tax to the public purse. The Treasury offers significant tax advantages to write down the cost of debt against taxes due; this encourages and supports over leveraging.

  BVCA repeatedly states that most investors in PEF's are onshore and subject to UK taxation. There is no evidence supporting this view, as PEF's are secretive about their investors and there is no way of evaluating this claim.

  We believe that PEFs should be forced to be British companies paying appropriate taxes, so contributing fully to our economy. The price of investing in our companies should be a proper tax contribution, which indemnifies the economy in the event that interest rates rise and these over leveraged companies collapse.

  A good current example relates to the takeover of Boots by PEF's, who have offered £10.1 billion to take over Boots, of which £7 billion will be debt. The interest payments on this debt amounts to more than £500 million per annum, as against Boots predicted profits of £480 million this year. The reason that this debt restructure will work is that the interest payments will be written off against corporation taxes, which will then not be contributed to the public purse. In a normal tax situation Boots would have contributed £144 million in taxes on a £480 million profit. Effectively the PEF uses tax arbitrage to pay for the company using debt to avoid contributing to the economy with taxation.

  Whilst we are not against tax advantages that encourage investment in British companies, we believe that such advantages should be geared to long-term investment of ten years or more.

  It is difficult to predict the long term economic impact of PEF's because we have never been through a cycle where there has been so much investment in, and activity by PEF's.

  What we do know is that these funds are heavily involved in existing British companies, and that they operate primarily to unlock value in the companies to redistribute to their own investors. This is not the primary objective of listed companies who operate to provide goods and services and to build shareholder wealth for the long term. PEF's are not invested for the long term, and indeed it is central to their business plan, that they get out of these heavily leveraged businesses as quickly as possible, so that they are not left with the economic burden of running the company when they multiple layers of debt repayments kick in.

  The PE industry has also been given a loophole in relation to taper relief on CGT, whereby provided they have owned a company for just two years their senior staff can benefit form a tax scenario where they only have to pay between 5 and 10% in capital gains tax on earnings through company schemes. This tax relief is not available to employees in publicly listed companies giving PEF's an additional benefit in relation to attracting senior executives. The fact that the relief is offered after such a short ownership of a company, as opposed to say ten year ownership, specifically encourages short term investment, which we believe is not conducive to good management of a company.

  A particular concern we have is that by allowing PEFs not to pay taxes, it is putting other companies at a disadvantage. Effectively they are subsidising private equity, and are placing themselves at a competitive disadvantage. The Governments tax policy regarding PEF's must inevitably have the consequence of encouraging non—PEF businesses to adopt the same types of financial and organisational practices in order to balance the marketplace.

  It cannot be right that only one type of financial and organisational model should dominate the economy, particularly when so many organisations are now raising concerns about the negative impact of PEF practices.


  Publicly listed companies are subject to wide public scrutiny and regulation. Directors have greater public accountability for their acts and omissions. They are required to be open and honest about their intentions and activities within the company. Shareholders have powers to control and monitor the actions of the directors. Accounts are public documents allowing anyone interested in the company to have a full picture of the long-term financial health of the company. The primary motivation and duty of company directors is the long-term sustainability and economic health of the company. They are focused on accounts, but also on staff morale, keeping good people, research and development of new products and services, providing effective competition to other companies within their sector. These activities benefit the lives of employees, the long-term development of the company and the health of the economy as a whole.

  PEF go into companies with an entirely different agenda. That agenda is about financial re-engineering of the company to extract maximum value in the short term. Valuable assets are sold or leveraged, the company is obliged to take on heavy debt, and staff is laid off to run the tightest possible operation. Long-term business management concepts related to research and development, and staff welfare and morale are not a priority because the PEF will not be involved with the company long-term. When the company is sold or floated it will be carrying far more debt, and in times of economic downturn is far less likely to survive, than a company that has more room to manoeuvre with low debt and unburdened assets.

  PEF's have no duty of public accountability and are not subject to public scrutiny. We have no real idea of the economic shape of their investments or how much money they are avoiding paying to the public purse. This cannot be advantageous to the running of a healthy economy.


  Our concerns about the impact of PEF's on industrial relations are by necessity anecdotal. PEF's do not allow human resources or industrial relations researchers in to their companies, so their claims and those of the BVCA are not open to independent criticism. We would suggest this is because they know that the results of independent research would show that their claims regarding job growth are false.

  The BVCA repeatedly quotes the work of the Nottingham Business School as supporting their contentions about the benefits of PEF in the workplace. They continually fail to mention that the part of Nottingham BS that produced their report is funded by Venture Capital.

  It is the case that many financial economists and business researchers believe that that there are positives and negatives to the tightly controlled human resources practices of performance management and monitoring that are usually imposed by PEF's.

  As a Union our experience does tell us that worker pay and conditions are changed after PEF investment. TUPE transfer rules do not provide adequate protections because PEF's who argue that performance management related changes to employment terms and conditions are not related to the transfer and are usually consented to by the employees who are afraid of losing their jobs.

  In summary there is not a lot of academic empirical work precisely because of the difficulties of access, and as a result we have no research or understanding on wider and longer-term impacts on the economy.


  In conclusion the GMB ask that the Treasury consider the fact that too much private equity investment is now a potential burden on the British economy. The special advantages that the Treasury has offered have been too attractive and PEF's now control a substantial part of the British economy, a percentage that inevitably continues to grow.

  As the amount of money chasing private equity grows, the firms themselves are less selective in their targets, are more focused on extracting funds for the companies to repay their investors, they take on more high risk debt, they are more focused on getting in and out of the company in the shortest possible time.

  The focus of PEF's is entirely related to extraction of value for their investors. In relation to short-term investments these goals are inconsistent with running a company with a healthy economic profile.

  Treasury needs to remove the economic advantages for short-term investors, and only reward investors who stay with companies for the long term.

  Treasury needs to equalise the balance between private companies and those listed on the Stock Exchange so that publicly listed companies and the taxpayer are not subsidising private equity.

  Treasury needs to introduce a government regulatory authority to oversee the private equity sector. It is not appropriate for a sector that is involved with such a large sector of the economy to be unregulated, to the disadvantage of other more regulated sectors of the economy.

  Treasury needs to consider way to make PEF's more transparent and accountable so that their intentions are clear, and the way their investment funds are made up and repayable is apparent. Unless there is transparency, there can be no protection against conflicts of interest.

  Treasury needs to consider the balance between the massive amounts of tax that are being legally avoided by PEF's and their investors and the advantage this is giving them over listed companies, as against the cost to the public purse and the amount of value being stripped out of British companies.

  Treasury needs to evaluate the impact of even a small movement in interest rates in the light of the warnings now being issued throughout the economic community, and consider measures to protect the economy and the labour market in that eventuality.

  Treasury needs to consider what protections need to be put in place to protect existing collective bargaining agreements and the position of trade unions within companies taken over by PEF's.

  Treasury needs to be funding and supporting genuinely independent research into the social and economic impact of PEF's in Britain.

May 2007

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