Select Committee on Treasury Written Evidence

Memorandum submitted by Duke Street Capital


  Duke Street Capital is an established, successful, mid market private equity house.

  Duke Street Capital is committed to growing its companies for the benefit of all stakeholders:

    —  total employment across Duke Street's UK portfolio has grown on a like for like basis by 12% (an annual average rate of 3-4%).

    —  on average, capital expenditure per investee company in the last year of Duke Street Capital's ownership was more than double that in the year prior to Duke Street Capital's ownership.

    —  investment each year in Duke Street Capital companies was on average more than 30% higher than in the year preceding Duke Street Capital ownership.

    —  since 1994 Duke Street Capital's returns for its investors including over seven million pensioners were almost double those returned by the FTSE 100.



  Duke Street Capital is an independent private equity firm majority owned by its staff with offices in London and Paris.

  It was founded as Hambro European Ventures in 1988 and focuses on mid-market leveraged buy-outs, investing predominantly in established UK and French businesses with enterprise values of up to €500 million. The business changed its name in 1998 when it was the subject of a management buyout from Hambros plc.

  It employs 36 people in London and Paris of whom 31 own shares in Duke Street Capital. It has an investment team of 17 and 19 support staff focused on investor relations and reporting and regulatory compliance. It is supported by 10 operating partners who are former senior industry executives and who although non executive, help Duke Street in all aspects of its investment process and will typically also provide practical assistance to portfolio companies by going onto the board of those companies as non executive Chairmen.


  Duke Street Capital has raised six private equity funds to date totalling in excess of €2.5 billion typically from institutional investors ie pension funds, fund of funds (ie funds which themselves invest in private equity funds), banks, family endowments and insurance companies. Its last fund completed its successful fundraising earlier this month. 52% of this fund was raised from overseas investors, representing a significant inflow of foreign capital to the UK economy benefiting our investee companies, our employees, pensioners, consumers, suppliers, professional firms and everyone else involved with our fund companies and transactions. Over seven million pensioners have benefited from Duke Street's investments as members of pension funds investing in funds managed by Duke Street Capital.

  Duke Street does not enjoy the benefits of permanent capital ie continued employment with Duke Street is dependent on continuing to raise regular funds. Funds are raised in competition with other private equity firms and other asset classes and availability will also depend on economic conditions. However, ultimately the ability to raise money will depend on the performance of previous funds and Duke Street Capital's successful relationships with its investors.

  Duke Street Capital Funds are 10 year funds with primary investments to be made in the first five years and all exits achieved before the end of the fund. Duke Street Capital's typical hold period is three to five years although a small number of investments were sold earlier and some held for longer.

Mid market and Duke Street Investment Activity

  Duke Street Capital defines as mid market, companies with an enterprise value of between €50 million and €500 million. It is not possible to be definitive since every company is different but mid market companies principally because of their size and often youth:

    —  will present growth opportunities whether through buy and build or organic growth.

    —  may present a riskier investment profile than larger more mature companies.

    —  typically have less developed financial reporting and governance systems.

  Duke Street Capital's mid market investment strategy is to:

    —  avoid competitive auction situations when buying companies;

    —  only buy into areas of operational experience following a thorough due diligence exercise;

    —  seek companies that allow it to create value through growth rather than relying on financial engineering for its returns;

    —  apply best practice corporate governance to all its portfolio companies;

    —  ensure it is heavily resourced for the number of companies in its portfolio to allow full value transformation and implementation of proper governance;

    —  ensure that it prepares a company for sale with significant future growth prospects to ensure full value for Duke Street on exit.

  Duke Street Capital has a record of supporting and growing businesses by providing substantial capital for their growth. On average capital expenditure in the last year of Duke Street Capital's ownership was more than double that in the year prior to Duke Street Capital's ownership and annual investment was on average more than 30% higher than in the year preceding Duke Street Capital ownership.

  We are clear that the only way to create consistent returns over the economic cycle is to create strong businesses with substantial market positions that are attractive to buyers on exit.

  Good examples of this strategy are:

    —  Paragon, a leading provider of long term residential care services in the UK that looks after some of society's most vulnerable, severely disabled individuals with significant learning disabilities. Duke Street Capital over a period of five years created 680 new beds on the back of further capital investment, increased staff numbers from some 3,000 to over 4,754 while at the same time increasing the turnover of the company from £44 million to £100 million;

    —  Gala Bingo, where Duke Street Capital created through a buy and build strategy the biggest bingo operator in the UK before selling it on when it felt that the company's growth plans required capital investment beyond Duke Street Capital's investment remit. Gala's growth has continued under new ownership becoming a company with turnover in excess of £500 million employing over 9,000 people.


  Duke Street Capital is a fund management business which acts as General Partner to a series of Limited Partnerships—these Limited Partnerships are customers of Duke Street for regulatory purposes. Duke Street is authorised and governed by the rules of the Financial Services Authority (the FSA). Duke Street reports annually to the FSA, and is audited annually for its compliance with the FSA Rules. In addition the FSA has historically carried out themed visits to verify compliance.

  Although its ultimate obligation lies with its investors, Duke Street Capital has always been conscious of the role it plays within society and the interests of all stakeholders ie staff, unions and pensioners in all its activities.

  Specifically on pensions, the pension legislation has imposed a stringent regulatory regime that potentially imposes liability on both investors and directors. The pension position is a fundamental element of any investment decision and thereafter any further financing or other significant corporate event. In all of Duke Street Capital companies where there have been defined benefit schemes, levels of funding have either been maintained or increased and there have been no examples of scheme insolvency.


Taxation of Private Equity Management Companies and Executives

  For information:

    —  Duke Street Capital generates income through and pays its costs out of the profit share it earns on the fund (typically 1.75% pa of committed funds for the first five years of the fund and then the same percentage of the cost of any acquisitions still left in the fund);

    —  the Duke Street Capital group management companies all pay corporation tax at the full rate of 30% on their receipt of fees from managing the Duke Street Capital funds;

    —  UK based Duke Street Capital employees pay NICs and full income tax on all salaries and bonuses;

    —  all except one of Duke Street Capital's partners operating in the UK are UK domiciled for tax purposes. As such they all pay capital gains tax on any increase in the value of their personal investment in the fund and any carried interest that may become payable whether related to UK or non UK capital gains.

  Duke Street Capital is clear that carried interest is appropriately characterized as capital and therefore falls within the capital gains tax regime. Carried interest is long term risk capital that:

    —  only becomes payable typically seven years into any fund and then only if the fund has succeeded in returning investors capital, costs and management fees and an 8% compounded interest rate on all these items. By contrast the FTSE All Share index has returned 4% per annum since its inception in 1999;

    —  is based on a basket of underlying unlisted company shares;

    —  is agreed following negotiation with investors prior to the establishment of any fund and contingent on the investment by executives of a significant amount of their own money;

    —  represents a share of investors capital returns that they agree to as a valuable way of aligning their interests in their capital investment with those of the investment team.

  Duke Street Capital would be very concerned on the impact of any potential changes to the tax regime which might adversely impact on:

    —  management teams, who like private equity professionals, typically also commit a significant element of their personal wealth and working lives to growing and therefore creating value in investment companies with the commensurate advantages to all;

    —  workforce share ownership generally.

Deductibility of debt interest

  Duke Street Capital strongly believes that the current regime should remain with full deductibility of interest on third party debt. Duke Street Capital notes that:

    —  the current rules apply to all companies (whether private or public, private equity backed or not);

    —  Duke Street Capital debt structures typically include significant capex facilities;

    —  capital investment is the lifeblood of any growing organisation and any proper business expense (like interest) should be tax deductible;

    —  the vast majority of lending to Duke Street Capital companies is by UK based financial institutions who pay tax on interest received.

Excessive Debt Levels

  Duke Street Capital seeks to assess appropriate debt levels based on the economics of each individual company and its likely future growth and existing and future interest rates.

Disclosure/Corporate Responsibility

  Duke Street Capital recognises that private equity is now playing an increasing role in the UK economy and that its activities may impact an increasing proportion of the population directly. Accordingly, Duke Street Capital supports higher levels of disclosure in relation to itself and investee companies.

  Duke Street Capital supports disclosing relevant financial fund returns generally, which are already available to the institutional investors investing in the asset class.

  On its portfolio companies, Duke Street Capital supports a wider discussion about appropriate levels of corporate disclosure. For a number of smaller companies excessive disclosure beyond statutory reporting would be unnecessarily onerous. One potential idea would be a requirement for companies with debt in excess of £100 million to produce annually a financial report with the same levels of information produced by quoted companies.

  For information, certain Duke Street Capital portfolio companies have already done this as a matter of course for the benefit of stakeholders, typically staff, suppliers and customers; a copy of the 2e2 annual report is attached by way of example.

  As noted above Duke Street Capital will always apply best practice corporate governance to all its portfolio companies. In addition to this it will work in accordance with its own Social Ethical and Environmental Investment Policy. Finally it is aware of and looking to see how it might participate with the Forum for the Future's work on Sustainable Development and Private Equity.


  Duke Street Capital acquired Burtons in March 2007 from Hicks Muse another private equity firm. Burtons operates in a sector of Duke Street Capital expertise which it has been following for a significant period of time and in which it has already made a number of investments.

  The profile of any investment and the route to profitable growth is different for every investment. In this case Duke Street Capital was aware at the time of purchase that changing lifestyle habits had led to generic overcapacity in the traditional biscuit making market which would inevitably need to be addressed. Duke Street Capital was clearly aware of the manufacturing review already being carried out by Burton's management team at the time of purchase, although no firm proposals had been made at that time. In particular Duke Street Capital notes that all disclosures and communications have at all times had to be conducted within the constraints of the statutory consultation processes.

  Specifically, Duke Street Capital and Burton's management met political, trade union and regional development representatives to confirm their commitment to the consultation process and to ensure that appropriate information was made available to facilitate alternative proposals. Having said this all parties are aware that there is an issue of industry overcapacity that will have to be addressed within the Group to ensure the company can thrive and grow in appropriate, sustainable directions.

  The Duke Street Capital investment strategy for Burtons is based on driving existing brands and new product development targeted at the most attractive market segments (including for example the savoury segment). This will involve significant capital investment into the Group, for example in organic products baked at the company's Edinburgh factory. Also with Duke Street Capital's backing, Burton's should be the best placed player to drive consolidation in a fragmented industry.


  This is an investment in which Duke Street Capital has been involved for 19 years. During this time Duke Street Capital:

    —  grew the company from seven stores to over 450 employing over 16,000 staff;

    —  turned unprofitable companies into profit, saving significant numbers of jobs;

    —  created a third national force in the UK DIY market to counterbalance the market dominance of B&Q and Homebase;

    —  generated commensurate benefits in the Focus supplier base.

  In 2005 Duke Street Capital sold a part of the group, Wickes, to a trade buyer and used the proceeds to reduce debt and return cash to its investors. Debt multiples for the remaining group were no higher than prior to the disposal. A significant and unforeseen market downturn which also (affected Focus' competitors) did mean that existing debt levels became too high and led to Duke Street Capital managing the investment for two years effectively for the benefit of staff, pension beneficiaries and debt providers to ensure an appropriate exit to protect all of their interests.

  On exit, all stakeholders' interests were preserved apart from the holders of traded bonds (listed debt securities) who received 40p in the £1 and the equity investors who received nothing. Bond holders are professional investors who invested on the back of full initial and ongoing financial information as required by listing rules.

June 2007

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