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
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
1. THE REGULATORY
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 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
EquityA 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 MBOManagement
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
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'sPermira and Blackstoneraised
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
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
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
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
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 nonPEF businesses to adopt the same types of
financial and organisational practices in order to balance the
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
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
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
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
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
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
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.