Memorandum submitted by SVG Capital plc
1. Is the current regulatory regime for private
equity funds suitable?
1.1 In its latest Discussion Paper
the FSA considers the current regulatory treatment of private
equity to be sufficient and appropriate. With regards to investors
in private equity funds we believe the current regulatory regime
reflects the unique nature of access to this asset class. The
best protection for investors in private equity funds is through
careful due diligence of the GPs and the capability to closely
follow developments in the market. Thus while many individuals
have indirect exposure to private equity, the funds themselves
are only open to sophisticated market participants like insurance
companies, large or specialized asset managers and pension funds.
2. Is there sufficient transparency on the
activities, objectives and structure of private equity funds for
all relevant interested parties?
2.1 We believe there is sufficient transparency
in private equity to apply the due diligence which is essential
to the private equity model. GPs have a substantial interest in
giving sufficient access for LPs to carry out their diligence.
Were a fund not to give sufficient access and transparency we
would find it difficult to approve such an investment to our portfolios.
2.2 Some members of our group represent
publicly listed structures that invest in private equity and have
a clearly defined transparency and governance structure for end
investors and the public. This structure yields considerable value
for our investors.
2.3 The growth of private equity has brought
requests from other stakeholders such as employees, pension trustees
and unions for improved transparency. Private equity's strength
as a model lies in its long-term vision for creating value and
motivating parties to achieve that vision in portfolio companies.
As the end investors in these companies it is in our long-term
interests to ensure that all of the stakeholders have sufficient
2.4 We therefore strongly support the Walker
Commission's efforts to define a voluntary code of conduct on
transparency for private equity firms. We believe these efforts
will go a long way towards meeting the interests and demands of
the stakeholders described above.
2.5 Transparency at the regulatory level
has been well-addressed by the FSA in its recent discussion paper.
The FSA seeks to maintain a balance between the regulation of
private and public markets. It emphasizes the need to consider
the efficiency and proportionality of proposed regulation. The
paper also makes clear that the risks presented by public equity
are relatively low and that the FSA's interests mainly involve
monitoring. We support this view and would be pleased to consider
any proposals which sought to improve the FSA's ability to monitor
3. Has there been evidence of excessive leverage
in recent transactions and what systemic risks arise in consequence?
3.1 There have been several pronounced cyclical
trends in the average credit statistics
for LBOs during the last market cycle between 2000 and 2006. Average
debt levels as a multiple of EBITDA have risen (from 4.4x to 5.5x)
but senior interest coverage levels are broadly the same (from
3.5x to 3.4x). Higher debt levels have supported higher purchase
prices as a multiple of EBITDA (rising 20% including fees) but
the average equity contributed to those deals has risen 15% as
well indicating only a small increase in gearing levels.
3.2 These averages cover a large, diverse
and rapidly growing market (Europe30 billion in 2003
to 116 billion in 2006). Metrics for individual deals vary
widely, and it is possible some current deals have leverage which
is higher than can be supported by fundamentals. Evaluating appropriate
leverage levels is highly dependent on the specifics of company
and industry-level circumstances. As investors, leverage levels
are something that concern us and we monitor them carefully. However,
we believe company management and GPs are best at matching the
knowledge of a firm's operating risks and its choice of financial
3.3 Managers exercise considerable care
with regards to business cycles when choosing investments. Particular
attention is paid to the cover of free cash flows over interest
payments and the stability or risks to these coverage levels.
A further restraint on unwarranted leverage is that investors
in the debt of private equity-owned companies are able to exercise
extensive diligence and reviews of the operating company as compared
to those who invest in public companies. In our view the LBO-sponsored
companies are particularly well placed for changes in economic
conditions as these companies are chosen for the resiliency of
their cash flows irrespective of the operating environment.
4. What are the effects of the current corporate
status of private equity funds, including both their domicile
and ownership structure?
4.1 The partnership ownership structure
is time-tested and has evolved because of its suitability for
private equity techniques. The structure allows LPs to invest
over long-term horizons while providing significant flexibility
for GPs in investment selection while encouraging management to
focus on corporate strategy rather than day to day share prices.
This structure has proven to be beneficial for investors in maximizing
their returns while limiting exposure to their original commitment.
4.2 From the investors' perspective the
domicile does not play a significant role in our investment decision-making
5. Is the current taxation regime for private
equity funds and investee firms appropriate?
5.1 Private equity funds operated as limited
partnerships are tax transparent for end investors. This treatment
is appropriate as investors are liable for tax on capital gains
or income they receive and should not be double taxed. Thus investors
pay tax rates consistent with their own tax status whether as
individuals, pension funds, or companies. This means that the
tax status of private equity is not preferential to other forms
5.2 The treatment of tax deductibility of
interest on borrowing for investee firms has received much attention
recently. It should be noted that the tax treatment of these payments
is the same as for listed companies or other privately-held companies
and is not preferential for private equity owners. The benefits
of deducting interest as an expense for corporate investment has
an important effect on companies underlying cost of capital. Restricting
this benefit would increase the cost of capital, lower investment
and would thereby affect long-run productivity performance.
5.3 Public pension funds are a significant
beneficiary of private equity performance. They are the largest
UK source for commitments to UK private equity funds in 2005 (£1.5
Changing the rules for interest tax deductibility could negatively
impact returns for these funds.
6. Are developments in the environment and
structure of private equity affecting investments in the long-term?
6.1 The benefits of private equity to productivity
and economic competitiveness are considerable. Successful private
equity investment requires improved performance at the operating
company level. This improvement takes place through the reallocation
of corporate resources, a refocused strategy and/or improvements
of operational fundamentals. Thus through the successful practice
of private equity the economy as a whole sees improved performance
7. To what factors, including the current
macroeconomic context and position in the economic cycle, is the
current rise of private equity attributable?
7.1 Over the last four years the growth
in commitments to private equity (from 29 billion to 90
billion) and investments by private equity funds in Europe (from
27 billion to 50 billion) has been strong.
This growth has been driven by improvements in the business cycle
and a secular fall in credit risk premiums for corporate borrowing.
Both the private equity-driven LBO market and the public market
for M&A has benefited significantly from these trends.
7.2 Fund-raising for private equity funds
has followed the broad success of private equity managers in generating
returns. High returns, (both realised and unrealised) over the
last five years have encouraged existing investors to increase
commitments to later funds, while outperformance of other asset
classes has encouraged new investors, whose allocation to private
equity has been historically low, to increase their exposure.
8. What are the economic advantages and disadvantages
of a firm being owned by private equity funds as opposed to being
8.1 Private equity ownership benefits firms
through an alignment of incentives between ownership and management
and gives them the time to deploy multi-year strategies. Carrying
out a unified and focussed strategy allows management to create
long-term value within the company. Under private equity ownership,
management can focus on the business and does not need to respond
to share-price volatility. Driving this value creation strategy
is fundamental to providing a successful exit for investors. The
private equity structure brings together these incentive structures
with a long-term investment horizon. The combination of these
attributes gives the private equity portfolio companies the freedom
to execute bold strategies, to uncover operational efficiencies
or to change direction within a maturing industry.
8.2 The disadvantage of private equity is
that the partnership life is limited usually to between 10 and
12 years. This limited life requires that private equity funds
dispose of investee firms during this period regardless of their
future growth potential.
40 "Private equity: a discussion of risk and
regulatory engagement", Newsletter 06/6, November 2006.
Source: Statistics in section 3 are provided by S&P Leveraged
Loan Commentary and Data unless noted otherwise. Back
Source: BVCA. Back
Source: EVCA/ Thomson Financial/ PricewaterhouseCoopers. Back