Memorandum submitted by the Share Centre
Key to The Share Centre's ethos is the power
of ordinary share holders to hold bodies in which they have invested
to account. We believe that active share holders make a fundamental
contribution to encouraging corporate governance, and it is in
the long term interest of the UK to foster an environment to this
end. This paper therefore encourages the Treasury Select Committee
to examine the long term impact of private equity on shareholder
Businesses need to be held accountable for the
employment, goods and services they provide, the pensions, benefits
and taxes they pay, the regulations they observe and the innovation
they drive. Their power to shape society by these means must be
held widely accountable to prevent a schism between wealth creation
and wealth distribution. This accountability is delivered through
Ownership brings responsibility. As responsible
society is therefore a share-owning society. To foster and encourage
share ownership we recommend:
Giving private equity firms an incentive
for going public, so that ordinary people can participate.
Seeking international agreement on
maintaining a high percentage of public ownership.
Abolishing stamp duty on share purchases
in the public secondary market.
Creating a level fiscal playing field
for shareholder debt. The cost of financing acquisitions should
be an allowable expense for public companies.
The Share Centre is well placed to speak on
the economic advantages of firms being publicly listed as opposed
to being privately ownedone of the Treasury Select Committee's
stated priorities for examination. We believe passionately in
encouraging ordinary people to participate in the ownership and
direction of the businesses that shape the communities in which
Private Equity has drawn much media comment
over the past two to three months as a result of the sheer scale
of its activities. Over the past five years the world's largest
private equity firms have raised $551 billion (£276 billion),
and London shares the lead with New York in private equity activity.
The current private equity take-over of Alliance Boots plc may
be the first of a FTSE 100 firm, but it follows a substantial
flow of British business. Meanwhile at least four further FTSE
100 businesses are understood to be under review for exit from
the public market.
Who are the Private Equity firms?
The largest players are Carlyle, Kohlberg Kravis
Roberts, Goldman Sachs Principal Investment, Blackstone, Texas
Pacific, Permira and Apex. They are unlike the conglomerates of
old (Hanson, BTR, etc) in that they are not themselves quoted
vehicles; although Blackstone has stated its intention to float
in the near future. Their funds for equity purchase are raised
directly from very large, mainly institutional, investors. The
private equity firm may supplement them from its own resources,
then leverage the equity available with debt in order to assemble
finance for a bid. Significantsome would say excessivefees
will be levied on this investment, which will then be monitored
closely to ensure that business objectives are being met.
What are the key motivations?
Clearly profit is the overarching motivation
and with the scale of investment exceeding the GDP of many countries
it is easy to see how the returns can be very substantial. So
it is reasonable to ask how a private equity firm can find such
a source of enrichment that is not available through public ownership?
Part of the answer lies in a more clinical approach
to risk assessment. The stockmarkets' assessment of risk is based
on myriads of analysts using conventional risk measurement techniques.
These then have to be publicised, then matched against the risk
profiles of public market investors. However with a wide range
of derivative-based instruments available, the appetite for risk
for that part of their activity which is allocated for cash markets
is not extensive.
Private equity investors are therefore able to
"gear up" with leverage to an extent significantly greater
than in the public market; if a listed company were to follow
that route, its valuation may well fall due to insufficient demand
for that level of risk.
The tax treatment of private equity is a subject
which few accountants are prepared to discuss (FT, 26/4/2007).
However their principle advantage is in being able to offset interest
charges (on shareholder debt) against pre-tax profit in order
to substitute dividend tax (at 32.5%) and corporate tax (at 28%)
for increased capital value (taxed at 10% or less). The Private
Equity firms are therefore washing out the high-tax obligations
of the domestic economy with the low-tax environment of the global
economy; while many would regard this as tax avoidance it is,
in fact, a very common form of arbitrage for international institutions.
As the president of the Chartered Institute of Taxation says,
"there is a tendency for a private-equity owned company to
have a lower tax burden"". Probably somewhat of an understatement.
It has been claimed that private equity challenges
employment, and this is a major source of union unrest over their
activities. However their business model requires continued business
success, and this cannot be achieved simply by cost-cutting and
asset-stripping. It is therefore important to look at the private
equity business perspective on a global basis. The key challenge
to domestic economies is the ability to re-locate and out-source
without the glare of these decisions being scrutinised by the
public markets. Private Equity ownership therefore presents a
growing contingent liability for governments wishing to retain
influence over the wealth-creating sector of their economies.
The lack of transparency is, of course, a major
boost to private equity ambitions. Issues of business strategy,
taxation and corporate governance can all be handled more robustly
within a cloak of secrecy. However although this is a major ongoing
concern over their operations it is collusion between the directors
of target businesses and private equity managers which should
cause particular concern, since such collaboration cannot be regarded
as anything other than a conflict of interest. It is to be hoped
that the Companies Act of 2006 will result in a strong check on
such activities, but the part addressing conflicts of interest
is not scheduled for implementation until October 2008.
Why does Ownership matter?
There is, however, a dimension which is often
overlooked in the debate over private equity: it is the long-term
impact of removing businesses from accountability to the community
in which they operate. These businesses are, after all, essential
to the wealth creation which fuels the welfare state and the conscience
of the community towards the world at large. If ownership is disassociated
from this accountability, the schism between wealth creation and
wealth distribution will become ever more evident: the rich become
richer, and the poor, poorer.
Business also shapes the society which people
live in to a substantial extent, by:
paying pensions and benefits
observing regulations and codes of
providing structure and discipline,
in the widest sense
competing and innovating
and, of course, by supplying goods
The mutual appreciation of businesses for people,
and people for business, is vital for economic productivity, maintaining
a healthy trade balance, financing the public sector, and retention
of skills within the UK. That mutual appreciation is best served
by maintaining people's participation in the businesses they work
for and use either directly or through their pension funds and
other investments. Cash is not an acceptable substitute for this
long-term participation, either as deposits or by borrowing.
Most people would accept that ownership brings
responsibility: this is particularly evident in property, where
rented accommodation does not attract the same degree of occupier
care and attention as with home ownership. So it is with business:
ownership by the people, albeit indirectly, brings a sense of
responsibility. A responsible society is therefore a share-owning
What can be done to re-dress the balance?
Several measures could be taken to enable publicly-owned
businesses to compete on more level terms with those in private
equity within the United Kingdom:
Give private equity firms an incentive
for going public, so that ordinary people can participate (currently
the definition of a private equity company is limited to 99 shareholders).
Seek international agreement on maintaining
a high percentage of public ownership.
Abolish stamp duty on shares to breathe
liquidityand therefore improved valuationsinto the
secondary market. This will also substantially benefit pension
funds and make it easier for smaller businesses to raise capital.
Introduce a level fiscal playing
field for shareholder debt, as regards treatment of interest payments.
It is worth bearing in mind that the human quest
for leveraging open a chink of opportunity in order to extract
value is boundless. Civilisation determines that this worthwhile
characteristic is kept in check for the benefit of all, and the
balance of government and business makes this possible. The phenomenon
of private equity seeks to break out of this check by moving its
sphere of action to a level where government is weak: the global
business environment. It is therefore necessary to tread with
caution so that the national economy offers the same benefits
to the equity owner in both spheres, but retains influence over
good corporate governance through public ownership.