Memorandum submitted by T&G
The T&G welcomes the Treasury Select Committee
inquiry and the opportunity to submit evidence. The T&G represents
800,000 members employed throughout all sectors of the economy,
including the food and drink industry, manufacturing, transport,
commercial and contract services as well as the public and voluntary
sectors. The T&G has recently merged with Amicus to form the
UK's largest trade union of over two million members.
The T&G responded to the FSA's discussion
paper Private Equity: a Discussion of Risk and Regulatory Engagement
as well as to the European Commission Internal Market & Services
DGs "Report of the Alternative Investment Expert Group"
1.1 The T&G believes regulation and
rights are needed in three broad areas to ameliorate the negative
effects of private equity. These are employment rights, transparency
1.2 Workers and their representative should
be informed and consulted on the business and financing plan of
any takeover prior to the acquisition. Through their trade unions,
workers should have the right, equivalent to that of pension fund
trustees, to seek fair compensation and protection should substantially
greater levels of leverage be part of a private equity (or any
other) takeover. In private equity transactions, banks are able
to charge risk adjusted rates of interest, pension trustees exercise
the right to demand greater up-front funding to compensate for
added risk, but presently workers are not consulted let alone
protected or compensated. The T&G proposes that regulation
should include extending the Transfer of Undertakings (Protection
of Employment Regulations) or TUPE to cover transfer through share
purchase as well as strengthening of Information and Consultation
1.3 The information rights of employees
in private equity companies should be strengthened by regulation,
so that audited information at least equivalent to Companies House
accounts is made available to all stakeholders including employees,
their unions, suppliers, the local community and investors. This
should include an obligation to transparency by provision of the
information online and an annual CEO report.
1.4 Changes to tax should include abolition
of tax relief for interest on debt and taper relief must be withdrawn
from "carry" in private equity investments.
1.5 These recommendations arise from a number
of concerns about the impact of private equity on our members
and the enterprises the work for.
1.6 First, we do not believe the industry's
claims of job creation; our experience of redundancies, and the
consequent cost to families and communities, tells us otherwise.
The T&G commissioned a preliminary analysis
of the private equity industry's assertions and the surveys on
which they are based. The main findings, presented here, are:
1.6.1 The major surveys conducted for the
UK, EU, and USA private equity associations suffer from a number
of flaws, both in sampling and in data quality.
1.6.2 Problems of self-selection and the
difficulty of verifying data on employment arise from the information
opacity that is a systematic feature of private equity buyouts.
1.6.3 There is no overall effect on employment
compared with other forms of ownership;
1.6.4 An indication that buyouts generally
1.6.5 Claims about returns to investors
in PE funds are susceptible to confusion and exaggeration because
of the same problems of information asymmetry.
1.7 The T&G believes that the Government
should commission independent research on the impact of Private
equity on jobs as well as wages and conditions.
1.8 Second, the high leverage crucial to
the private equity buyout model shifts risk, often dramatically
so onto other stakeholders, primarily the workforce, who have
no compensation or protection. In the unprecedented stable economic
climate that has existed during the last 10 years in the UK, private
equity leveraged buyouts have had a negative impact on the wages,
terms and conditions and job security of workers. Less favourable
economic circumstances would further increase the risk and whole
swathes of the UK business could face financial distress, which
would further damage the interests of workers in those companies.
1.9 The overall UK economy could be seriously
damaged by the high-risk nature of private equity leveraged buyouts
of what is now a very substantial part of the economy. In less
favourable economic circumstances, this could generate a high
rate of failures of private equity owned companies, a calamity
for enterprise that could in turn damage the banking system of
1.10 Third, a significant source of the
"value" created by buyouts simply comes from radically
reducing tax as a result of interest tax shelters from high leverage.
As such private equity activity undermines public revenues which
must ultimately be recovered elsewhere in the form of higher taxes
on those who cannot avoid tax. It is completely unacceptable that
general partners in private equity firms may face effective tax
rates of 5%-10% in incomes of £ million whereas employees
pay far higher on modest income.
1.11 Fourth, the T&G is concerned that
private equity does not invest in the companies to the same degree
as publicly quoted firms. Private equity firms impose higher hurdle
rates on a company which directly lowers investment. The limited
term nature of private equity ownership has a further negative
effect. Intangible asset investment, in for example R&D and
employee training, appears to be particularly affected.
2.1 The impact of private equity in the
UK and globally is growing. Private equity raised globally has
reached $400 billion, equivalent with leverage to around $2 trillion
in potential buying power. The size of the funds has grown with
$10 billion funds now common, and mention of funds of up to of
even $100 billion in the future. With funds collaborating together
in club or "cartel" deals to bid, no company is immune
from potential take over as well as risks being bigger. Private
equity leveraged buyouts means that private control over businesses
is being achieved by the provision of a significantly reduced
level of equity. A key distinguishing feature of private equity
acquisitions from traditional acquisitions and mergers is their
reliance on heavily leveraged debt.
3. IMPACT ON
3.1 The T&G does not believe the industry's
claims of job creation; experience of redundancies, and the consequent
cost to families and communities, tells us otherwise. The T&G
does not accept what is essentially a money making endeavour for
a privileged few being spun as being a job creation scheme. Given
that the industry has operated outside the realms of public scrutiny,
it is important to look at the facts behind the figures claimed.
3.2 The T&G therefore commissioned a
preliminary analysis of the private equity industry's assertions
and the surveys on which they are based. The main findings are:
3.2.1 That major surveys conducted for the
UK, EU, and USA private equity associations suffer from a number
of flaws, both in sampling and in data quality. Recent surveys
in the UK by academics and journalists avoid many of these problems.
3.2.2 That most of the assertions made by
commentators, and some made by the reports themselves, cannot
be justified on the basis of the evidence from existing surveys.
The most reliable results suggest that buyouts generally depress
wages but there is no overall effect on employment compared with
other forms of ownership, and certainly not a positive effect.
3.2.3 Problems of self-selection and the
difficulty of verifying data on employment arise from the information
opacity that is a systematic feature of private equity buyouts.
Claims about returns to investors in private equity funds are
susceptible to confusion and exaggeration because of the same
problems of information asymmetry.
3.2.4 That there is a need for detailed
research on the actual impact on employment, pay and industrial
relations in each buyout in recent years and much stronger information
rights for employees and investors both before and after buyouts.
3.3 The T&G believes that the Government
should commission independent research on the impact of private
equity on jobs including on pay and conditions.
4.1 The T&G concern is with the leveraged
buyout model of private equity, where up to 90% of the cost of
acquisition is funded by debt and 10% by equity, which reverses
the usual financial structure of typical public firms.
4.2 The T&G believes that inherent in
highly leveraged buyouts is an unbalanced risk/return realitywhere
workers have to take undue risk in order that private equity funds
and managers may make undue returnsthat needs to be rectified
by regulation and rights. While Pension Funds and debt providers
get compensation for the additional risk resulting, workers have
no such protection or compensation.
4.3 With a private equity leveraged buyout,
debt used to finance the buyout is loaded onto the accounts of
the target company, not the private equity fund, and the bought-out
firm has to meet the interest payments. This means that the financial
structure of the company has been radically transformed.
4.4 Private equity's first step on acquisition
is to "recapitalize" the firm, that is, to increase
the firm's borrowing and, correspondingly, reduce the amount of
equity finance. This leads to a dramatic increase in leverage,
with a number of consequences:
Leverage explains the spectacular returns
4.5 Firstly, it is leverage that explains
the spectacular returns: Leverage minimizes the amount of equity
capital the private equity investors need to commit. If private
equity targets a firm worth 10 and thinks they can turn it into
a firm worth 12, then that is a 20% return. But if they can persuade
banks to provide nine of the 10, then their return becomes 200%.
The effect of leverage on jobs
4.6 Secondly, the burden of debt serviceinterest
payments and scheduled debt repaymentsis used by private
equity as an instrument to force management to focus on costs
and cash flow. Management is driven to cut costs because increasing
EBIT (earnings before interest and tax) is the only way they can
relax the shackles of the interest cover covenant. Private equity
likes to describe this as a tool for enhancing efficiency. In
well-managed firms it means managers have to cut muscle, not fat.
4.7 The T&G believes that there are
two very serious negative incentive effects of high leverage.
Employees are the stakeholder group whose claim is most vulnerable
to private equity. Labour's contract with the firm tends to be
"incomplete", in the language of contract economics.
It typically involves high levels of trust, and performance cannot
usually be fully specified in advance. Employees frequently build
significant employer -specific capital, and family ties, amongst
other factors, can make their mobility costly and often not possible.
In our experience these factors make workers most vulnerable to
private equity that feels unconstrained by pre-existent loyalties
and agreements and which is unconstrained by the discipline of
public accountability. The result may be in job losses and in
pay restraint, and a negative the impact on job quality. The mega
rewards of the few are partially funded by the job, pay and condition
sacrifices of the many.
4.8 One of the most insidious effects of
private equity is to increase the demands upon workers, and levels
of stress and job uncertainty. Anecdotal evidence also reports
dismay amongst human resource managers expected to "stretch
human assets" to meet new financial performance requirements.
4.9 Standard & Poors has stated that
the greater the quantity of debt a company held on its balance
sheet, the greater the chance of redundancy, erosion of pay and
conditions as the business struggled to repay its interest burden.
Higher debt leads to much harder work and more stress, not just
for employees, but also for stakeholders such as suppliers, who
are less likely to get paid. Even if the company doesn't default,
workers have less job security and are looking over their shoulders
a lot more, worrying what will happen if the company misses the
projections its debt is based on and struggles to make its repayments.
4.10 Furthermore, the cost cutting culture
of private equity is likely to reduce investment in intangible
assets, such as R&D and employee training, that are key to
success in the modern economy. Such spending usually directly
reduces EBIT and thus is an obvious target for cost-focused managers.
4.11 Private equity engages with workers
on a "heads we win, tails you lose" basis. If a highly
leveraged buyout goes well, private equity principals and senior
managers receive huge returns. Even in cases that turn out positively,
the most workers can expect is that a few extra jobs are created.
Certainly there is no sharing of the rewards with workers whose
livelihoods have been put in jeopardy by the high leverage.
Leverage and tax
4.12 Private equity maximises the tax benefits
of gearing. Debt finance is tax privileged in most countries;
generally speaking, interest is tax deductible whereas dividends
to equity are not. As a result firms significantly reduce or even
entirely eliminate their tax liabilities.
4.13 Tax economists have long been aware
of the asymmetry between the treatment of debt and equity and
many solutions have been discussed, and some attempted. The issue
could be ignored when firms were relatively conservative in their
gearing practices. But if a significant source of the value created
by buyouts simply comes from interest tax shelters from high leverage,
government should urgently consider limiting that shelter, both
on incentive grounds and to protect revenues.
Leverage and financial risk
4.14 The final effect of leverage is to
increase the financial risk of the firm, and thus the risk of
default, thus shifting risk, often dramatically so, to other stakeholders.
4.15 Inevitably, given the very high levels
of gearing, the associated debt frequently has a lower credit
rating, implying a higher perceived risk of default. Traditionally,
we understood that a firm's ability to service debt is a function
of the volatility of its EBIT, which reflects its business riskthe
vulnerability of sales to changes in economic conditions, and
its operating leveragewhich describes the extent to which
its costs remain fixed as sales change. These factors differ significantly,
business-to-business and sector-to-sector, which is why we traditionally
observed a wide range of gearing ratios in practice. This conventional
wisdom remains relevant to judgements today about private equity
4.16 The UK FSA report "Private Equity:
a Discussion of Risk and Regulatory Engagement", states that
"the risks inherent in the private equity market are not
confined to the private equity fund managers/advisers. Rather,
they affect all types of participant in varying proportions including,
in particular, fund managers/advisers, leveraged finance providers,
transaction advisers and investors in the relevant equity, debt
and related derivatives products." There is no mention of
other stakeholders, including labour, there.
4.17 Given that the growth of private equity
has taken place in the context of an unprecedented stable economic
environment, in less favourable economic circumstances the negative
impact on pay and jobs would be greatly magnified as a result
of Private Equity buyouts because whole swathes of the UK economy
could face significant financial distress, if not administration.
4.18 High and rising leverage in parts of
the corporate sector is identified as one of six sources of vulnerability
for the UK financial system according to the Bank of England's
Stability Report; the IMF has also expressed its concerns. The
growth of sub investment grade corporate bonds and high-risk debt
poses further risk.
4.19 Additional debt being added to acquired
firms as a result of so called dividend recapitalisations and
secondary buyouts adds to all these concerns.
4.20 After acquisition additional debt may
be used to fund dividend recapitalisations whereby the owners
of the firm are paid a bonus based on borrowing even more debt,
not based on growth on earnings. When Hertz was taken over by
Private Equity they took out £1 billion in dividends within
six months after acquisition. Some $30 billion (£16 billion)
of debt was issued globally by private equity-owned companies
to fund dividend payments for investors in the first six months
of 2006, according to Standard & Poors, who also considered
that rises in dividend recaps could increase defaults.
4.21 The increase in secondary buyouts (when
an acquired company is sold on to another private equity firm)
exacerbates all these problems and raises additional concerns.
How does private equity make returns, and the returns that they
claim, from a business that was previously owned by private equity,
without adding further to risks above, particularly in relation
to jobs? Why, if a business has longer-term prospects for growth
(and is hence attractive to another private equity firm) is it
sold on? If another fund can generate further returns why does
the original pprivate equity owner not retain it?
4.22 The T&G urges the Treasury Committee
to regularly report on the rise and quality of corporate debt
and the implications for economic stability.
4.23 Other charges associated with the private
equity leveraged buyout, such as fees for completing the deal
and annual management fees, are also loaded onto the acquired
company's accounts, not the private equity fund. For example had
a private equity firm been successful in a £10 billion bid
for Sainsbury's, it is estimated the firm would have received
from Sainsbury's an immediate fee of £50 million (a 0.5%
fee of £10 billion) simply for completing the acquisition,
as well £30 million a year in management fees. It appears
to the T&G that such fees are excessive and reward the general
partner even if an investment turns out badly.
4.24 Given the cartel like nature of the
private equity industry, the T&G urges that the fees charged
by the general partners are investigated by the Competition Commission.
4.25 In the following sections we address
elements of public company law and employment rights that we believe
should be equally applicable when ownership is transferred to
Private Equity enterprises. The case we make is for consistency,
equity, protection and fairness, and the issues we address are
those of consultation, recognition and representation rights,
transparency, taxation and investment.
5.1 Workers and their representative should
be informed and consulted on the business and financing plan of
any takeover prior to acquisition, and "exit". Through
their trade unions workers should have the right, equivalent to
that of pension fund trustees, to seek fair compensation and protection
should substantially greater levels of leverage be part of the
financing plan. Our members, bear a number of uncompensated costs,
in addition to the risk of default itself, but receive no premium
to compensate for the increased financial risk for example downward
pressure on wages. Banks charge risk adjusted rates of interest,
pension trustees have the right to demand greater up-front funding
to compensate for this added risk, but presently workers are not
consulted, let alone compensated.
5.2 Before a leveraged buyout has taken
place workers need to have proper information and consultation
about the financing and business plans and full recognition and
negotiation rights at all levels. Workers and their trade unions
need be informed and consulted regarding the business and financing
plan of any takeover prior to it happening. This should include
the right to adequate protection should substantially greater
levels of leverage be part of the financing plan similar to the
negotiating leverage available to pension trusteesie, the
right to insist upon fair compensation for the extra risk to them
due to any substantial increase in the leverage of a company as
a consequence of a takeover. It is not acceptable to for workers
to be kept in the dark about as important an issue as the potential
acquisition of their enterprise by a private equity buyout with
all the implications for their future that might result.
5.3 Trade unions and workers employed by
firms owned by private equity should be informed and consulted
to the same degree as workers employed in public companies. This
is particularly so given the financing of the buyout and the massive
changes to the financial structure of the firm and Information
and Consultation rights should apply. Rights are essential to
ensure that workers are not merely seen as liquid assets in a
short term ownership cycle of acquisition, restructurings and
5.4 The TUPE regulations exist to protect
workers in the event of a transfer of undertakings. Information
and consultation rights are critical in circumstances of a change
of ownership. The T&G believes that the TUPE regulations need
to be amended to cover circumstances where a change in ownership
arises through share purchase. The T&G learned that Gate Gourmet
was no longer owned by Texas Pacific Group from the following
press report: "A day after Texas Pacific Group joined other
powerful private equity houses in a call for more transparency,
the firm's mystery sell-off of Gate Gourmet reveals just how much
work the industry has ahead of it. Texas Pacific Group, which
bought the airline catering firm in late 2002 from Swissair, has
quietly reduced its stake in the business over the past year without
any disclosure, selling the last piece to Merrill Lynch on Thursday."
(Source: Reuters 2 March 2007).
5.5 Private equity has a hands on approach
to the acquired firm. The Financial Services Authority says "The
Private Equity business model is not constrained to capital provision,
rather it extends to the application of expertise and strategic
vision to the privately owned companies". Unions should not
end up trying to negotiate with a management that is no longer
the prime decision making body. Real decision makers need to be
present for negotiation and representation to be meaningful and
effective. The decision makers need to be clearly identified.
5.6 In summary trade unions need the right
to be informed and consulted on the financing and business plan
prior to a bid, and have the right equivalent to that of pension
fund trustees to seek fair compensation and protection, proper
recognition of trade unions is needed after the acquisition and
terms and conditions need protection.
6.1 Public companies are subject to a range
of reporting requirements, and information is typically publicly
available through published accounts, media scrutiny and published
6.2 Private equity firms, on the other hand,
do not have the same obligations to transparency. One effect of
a private equity buyout is to create an "information monopoly",
in which the beneficial owner determines what, if any information
is divulged. If Sainsbury's, responsible for the sale of a significant
proportion of food consumed in the UK, had been taken over its
disclosure obligations would have been drastically reduced. This
information monopoly creates asymmetries that are problematic
not only for employees and unions but also for investors and policy
makers. The barriers between workers in the acquired firms and
fund managers are massive.
6.3 The T&G therefore believes the information
rights of employees, their unions in private equity acquisitions
and investors should be strengthened by regulation, so that audited
information at least equivalent to Companies House accounts is
made available to unions, suppliers, the local community and investors
and that this should be made publicly available on the Internet
to facilitate independent research and that reports from CEOs
on company strategy should be made available to all stakeholders
at least annually.
7.1 Private equity transactions are structured
to radically reduce, or entirely eliminate, taxation. The key
T&G areas of concern are as follows:
7.2 The tax deductibility of debt interest,
associated with very high private equity leverage, means that
investee firms pay much reduced corporate taxes.
7.3 The practice of equity investors contributing
part of their capital as shareholder debt exacerbates this problem.
7.4 The T&G believes that tax relief
on debt should be abolished. The Danish model, whereby tax relief
of interest payments is eliminated in conjunction with off sets
elsewhere merits consideration.
7.5 Private equity firms are usually structured
as limited liability partnerships. This enables the general partners
to be taxed as individuals. In consequence, and in the UK, they
have been able to have their gains subject to the highly favourable
"taper relief" rules. These rules enable individuals
holding unquoted business assets to reduce the tax rate on a capital
gain by three quarters after a two-year holding period.
7.6 The taper relief rules were introduced
with fractional ownership of smaller entities in mind, to encourage
business investment. They were not introduced with private equity
investors in mind and the T&G suggests that taper relief be
withdrawn from "carry" in private equity investments.
7.7 It is sometimes suggested that private
equity is "tax motivated" and thus would, in part or
in whole, cease to exist if the tax system were changed to eliminate
the tax treatments and tax loopholes that private equity exploits.
The T&G does not share this view. Private equity investors
can realise very large amounts of cash from the purchase, restructuring,
and subsequent resale of investee firms. These gains can provide
enormous returns to general partners in private equity funds,
whether or not they are beneficially taxed.
7.8 Therefore in our view, it is essential
that private equity be fully taxed for reasons both of public
acceptability and revenue protection. It is completely unacceptable
that general partners in private equity firms may face effective
tax rates of 5%-10% on incomes of £ millions, when employees
bear marginal tax rates, including social security taxes, that
approach 50%, on quite modest incomes. Deeply regressive and highly
visible inequalities such as these are highly corrosive in a modern
7.9 It is often pointed out that the tax-free
status achieved by much private equity activity threatens public
revenues. This is its immediate impact but, given the level of
public finances, the lost revenue from private equity must ultimately
be recovered elsewhere, by higher taxes on those citizens who
cannot avoid tax.
8.1 The T&G is especially concerned
that the private equity leveraged buyouts have negative effects
on investment. We are especially concerned about lack of investment
of short-termist Private Equity ownership of a firm, with exit
planned for a few years after acquisition. We have anecdotal evidence
to support this but believe that the Select Committee should commission
an independent and thorough study on the matter.
8.2 Our anecdotal evidence for specific
companies is bolstered by the following observations:
8.2.1 Private equity appears to shun businesses
requiring high levels of capital investment going forward. Providing
funds to support very significant investments has, to date, not
appeared to be their modus operandi which seems focused on taking
over firms that can generate high and stable cashflows to extract
either in the form of interest payments or dividend recapitalisations.
8.2.2 Private equity imposes a very high
rate of equity return on the businesses it acquireson the
order of 30+% after-tax per annum. This compares with returns
on equity in the publicly quoted sector of something on the order
of 10-20%. Combined with the much higher costs of debt for private
equity companies versus publicly quoted companies the effect is
to raise their weighted average cost of capital which effectively
becomes the hurdle rate for new investment decisions. On a theoretical
basis, this would have a substantial negative impact on the investment
level of companies owned by private equity firms.
8.2.3 The negative impact on investment
is further impacted by the short-term horizon of private equity
firms. Unlike public companies which view the future horizon as
unlimited, private equity firms are looking to exit their investment
in companies in three or five years. They are therefore seeking
to raise the profits of the companies they own as much as possible
as fast as possible (effectively looking to increase EBITDA to
a high level and then sell). This has two effects on investment:
126.96.36.199 As companies near the end of their
shelf life in a private equity portfolio, the hurdle rate for
making investments is raised even further. The T&G has had
it stated to it by managers of private equity firms on multiple
occasions that, "Unless the payback is within the year, we
are not allowed to make any investment." This extremely negative
attitude towards investment appears to be directly correlated
to the length of time a company has been owned within a particular
private equity limited liability partnership. Sure enough, once
this attitude is stated by management, the company is sold on,
sometimes to another private equity firm within a short period
of time. Accordingly, the T&G believe that the limited life
nature of the LLP's utilised by private equity, the maximum three
to five year time horizon for ownership, combined with the obvious
incentive of private equity general partners to sell a company
in order to collect their "20% carry", has a negative
effect on investment.
188.8.131.52 Investment in intangible assets,
eg, R&D, brands and employee trainingalso is likely
to be low as the return on these investments is more uncertain
and also likely to be beyond the expected holding period of the
private equity firm. Moreover, with this spending usually hitting
the profit and loss statement of the company immediately, it is
an obvious target for cutting for managers struggling to hit the
often very ambitious EBITDA targets agreed with their private
equity owners. The T&G has seen cases where investment in
employee training is cut markedly after a private equity takeover.
8.3 The T&G is concerned there is a
knock-on effect on publicly listed corporations though a similar
squeezing of investment and long-term planning. Private equity
leveraged buyouts puts huge pressure on other companies, who wish
to avoid being taken over, to sell off or cut productive facilities
while at the same time spending money on buying back its own shares
or issuing dividends. Thus, private equity may well be reducing
not only investment of companies they own but of the entire UK
economy. The International Union of Foodworkers describes this
as the imposition of "a levy on the real economy of goods
76 Hall, David (2007) Secrets and selectivity-obscuring
how private equity buyouts affect employment PSIRU University
of Greenwich www.psiru.org Back
Rossman, Peter (207) Presentation to trade union sponsored MPs
on private equity, International Union of Food, Agricultural,
Hotel, Restaurant, Catering, Tobacco and Allied Workers Associations Back