Select Committee on Treasury Written Evidence

Memorandum submitted by Legal & General Ventures Limited (LGV)


1.1  Legal & General Ventures Limited ("LGV")

  LGV is one of the UK's longest established private equity businesses having been a recognised and active participant in the UK private equity market since 1988 and is one of the leading financial sponsors focused on UK mid-market buyouts. Since that time it has invested in more than 100 unquoted companies and arranged in excess of £2 billion worth of investments, principally in UK mid-market management buyouts of between £50 million and £250 million. Via its annual limited partnerships, LGV has made investments across a wide range of industries—from residential homes for those with special educational needs to stationery suppliers, from pubs and restaurants to manufacturers of waste disposal products for the NHS.

  1.2  Like most of its mid-market private equity counterparts, LGV has made investments in businesses that are not necessarily glamorous or newsworthy, but which in many cases have contributed not only to the UK economy, but also to UK society. For example, one of LGV's current investments is a nationwide chain of dentists who are working to assist the government in its drive to improve access to NHS dental services. LGV's current portfolio also includes other healthcare companies eg hospitals, care homes and service-providers to the NHS. It is in this context that the contribution of LGV and the private equity market as a whole should be considered.

  1.3  LGV's current investment vehicle (LGV 5) has raised approximately 50% of its funds from non-UK institutional investors. A feature of the UK private equity industry is its success in attracting capital from overseas and in the resultant fee generation from its activities for London as a financial centre.


2.1  The regulatory environment

  Given the characteristics of private equity, we consider a "light touch" regulatory regime appropriate.

2.2  The economic context

  Recent press comment has focused on a small number of high profile corporates such as Boots, Sainsburys and the AA. These are not representative of the typical private equity investee company that the majority of the industry invests in. Private equity, in all its forms, has been a major contributor to UK economic growth.

2.3  Taxation

  Despite press and political claims to the contrary, the private equity industry enjoys no tax advantages over the rest of the economy.


3.1  Overview

  As part of a FTSE-100 financial services group which includes a fund management company, LGV is accustomed to a high level of regulation including areas such as conflict management.

  The recent Discussion Paper 06/06 issued by the FSA "Private equity: a discussion of risk and regulatory engagement" focused more on the "mega" deals rather than the smaller deals transacted by the majority of the private equity industry, including LGV. It also focused on areas, for example, whether public or private ownership is preferable and levels of debt in individual transactions. These are largely commercial matters for the market to decide.

3.2  Is the current regulatory regime for private equity funds suitable?

  There are two particular characteristics of private equity investing that support a "light touch" approach from the FSA. The first is that investors in private equity funds are predominantly institutional (professional investors) rather than retail (ie private individuals). Secondly, a firm like LGV in a typical year will make 2/3 new investments and will exit from a similar number. This low volume contrasts with the high volume characteristics of the rest of the financial services industry. In all respects, these transactions are subject to highly intensive scrutiny and due diligence procedures.

  The FSA's move to principles-based regulation has been helpful in ensuring a "light touch" regime as far as private equity is concerned. Given the above comments, this is the appropriate approach.

3.3  Is there sufficient transparency on the activities, objectives and structure of private equity funds for all relevant interested parties?

  Recent press coverage, including demands for transparency, sparked partly by the prospect of private equity houses looking to buy companies such as Boots and Sainsburys, has given the impression that all private equity deals involve high profile companies being bought by large investors. This is not the case—so should these demands that the public should have access to all sorts of commercial information apply to smaller private companies of the size that LGV makes investments in, such as Kingfield Heath or Verna Group where alternative sources of capital are not available?

  Limited partners, as sophisticated investors, generally demand a high level of transparency when making private equity investments. This is evidenced by the protracted negotiation over limited partnership agreement wordings—this document effectively forms a contract between the private equity manager and the investor—which protects the rights of the limited partner.

  Most private equity funds are structured as limited partnerships with a life of between five and ten years, with a General Partner (also a limited partnership) and a Manager. Reporting to investors has become more sophisticated over the last few years—LGV for example has set up a secure website where, amongst other facilities, investors are able to download their quarterly reports. These reports now include not just the financial statements but also detailed reports on each investee company showing their current trading position sourced from management accounts, future prospects and exit strategy. Our investors are happy with the information flow.

  The banks that provide debt financing to private equity companies also expect a high standard of regular, detailed reporting to ensure that there are no credit issues or if they do arise, that they are fully informed as to any actions taken.

3.4  Has there been evidence of excessive leverage in recent transactions and what systemic risks arise in consequence?

  The use of the word "excessive" is unnecessarily judgmental—there is no denying that the current debt : equity ratios are at a much higher level for private equity investments than they have ever been historically. This may be a reflection that leverage levels in UK firms have been too low historically rather than any systemic risk.

  The reasons for an increase in multiples are principally due to market demand—low interest rates and increasingly sophisticated financing techniques have led to new approaches to deal structuring. The ability of banks to syndicate the debt taken on also serves to spread any credit risk—it is however more than likely that a couple of spectacular failures will lead to a correction in the debt market, with banks reverting to a more conservative approach.

  It should not be forgotten as well that a large proportion of the funds invested are equity or quasi-equity (for example loan stock or preference shares). As the private equity industry has developed and matured, those managing investments have become more professional which has meant that borrowing difficulties can in most cases either be avoided or dealt with efficiently.

  At the end of the day therefore, the level of debt availability is a function of market forces.

3.5  What are the effects of the current corporate status of private equity funds, including both their domicile and ownership structure?

  In the case of LGV, its annual funds are structured as English limited partnerships established as Collective Investment Schemes under s.235 of the Financial Services and Markets Act 2000. The General Partner is an English domiciled company and the Founder Partner a Scottish limited partnership. The Manager is LGV which is an English domiciled company regulated by the FSA.

  This particular structure is one that has been used successfully, without any major modifications being necessary, during the growth years of the private equity industry. This ensures that the limited partners are taxed in the countries in which they are based.


4.1  Overview

  Despite press and political claims to the contrary, the private equity industry enjoys no tax advantages over the rest of the economy.

4.2  Is the current taxation regime for private equity funds and investee firms appropriate?

  The current taxation regime treats private equity funds and investee firms in the same way as any other similar private entity. LGV considers this to be appropriate and to do otherwise would give an unfair advantage to the public markets and stifle investment in private enterprise.


5.1  Overview

  The opportunities arising out of the economic growth seen in the past few years have resulted in the UK private equity industry being second only to its US equivalent as far as annual investment levels, both by value and volume, are concerned. Recent BVCA surveys have highlighted the fact that private equity backed companies create jobs at a considerably faster rate than other private sector companies—an increase of 9% pa for the five years to 2005-06 compared with 1% pa for FTSE-100 companies.

  LGV has direct experience of this through successful investments such as Tragus, the branded restaurant business. During LGV's ownership, 13 new outlets were opened and contracts exchanged on 12 more, as well as a new brand, Ortega, being launched. In February 2007 the Sunday Times Buyout Track 100, which measures profit growth in companies invested in by the buyout industry, included six current or very recent LGV investments in the top 100, which is a significant number given LGV's average portfolio size (approximately 10 companies).

  In the interests of promoting a dynamic and growing economy, the willingness of private equity to take on risks should always be balanced by political acceptance of an appropriate level of rewards.

5.2  Are developments in the environment and structure of private equity affecting investments in the long term?

  The growth in appetite shown by institutional investors suggests that they regard private equity as a superior form of corporate ownership to the public markets so what we may be seeing is a significant structural change.

5.3  To what factors, including the current macroeconomic context and position in the economic cycle, is the current rise of private equity attributable?

  Low interest rates and the successful fund-raisings of the last few years have resulted in significant funds being available for private equity investments. Indeed it is estimated that there is enough private equity funding available to purchase all companies listed on the LSE and Nasdaq.

  More funds have been directed towards private equity by pension funds in the last few years, in an attempt to increase returns to make up the deficits which many funds currently suffer from. Pension fund managers and trustees are now more willing to invest in private equity, based on the assumption that the increased risks are worth taking in order to put right the problems partially caused by investing in the public markets in the past.

  As far as equity is concerned, historic investment returns from buyouts have generally been superior to all other asset classes over the last ten years. Regarding debt investment, low interest rates and increased risk tolerance mean that higher levels of cash have gravitated towards private equity deals.

5.4  What are the economic advantages and disadvantages of a firm being owned by private equity funds as opposed to being publicly listed?

  The economic advantages of private equity ownership are simple:

    1.  The fact that a longer term view of a company's prospects can be taken in the absence of pressure from City investors means that operational improvements which might affect short-term profits can be made;

    2.  There is complete alignment of interest between shareholders and management in terms of financial reward; and

    3.  The closer hands-on involvement of private equity shareholders lends itself to an efficient corporate governance structure.

  The conclusion of the above analysis is that managers are left to run the business within the confines of a clear strategic plan agreed with its shareholders.

  The major economic disadvantage is the lack of short-term liquidity for investors.


  There is no doubt therefore that there are areas where government and the regulator have a role to play, in ensuring that the private equity industry can continue to contribute effectively to the British economy and to society as a whole. In the main, their contribution should simply be to allow the industry to get on with what it does best—growing and making more efficient businesses throughout the UK, accountable to professional institutional investors.

  If the UK private equity success story is allowed to continue within the right environment, the current statistic of its providing employment for approximately one in five of the British private sector workforce, as well as bringing in substantial overseas funds under management, can only improve.

May 2007

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