Memorandum from 3i Group plc
The structure and effectiveness of the recently
established BVCA panel for monitoring and encouraging compliance
with the code of conduct
We fully endorse Sir David's recommendations
and believe that the BVCA panel for monitoring and ensuring compliance
with the guidelines to be an effective structure to bring greater
transparency to the private equity industry.
The appointment of Sir Michael Rake brings credibility
and independence to the panel while further appointments will
bring further integrity to the panel.
It is significant that the panel will be independent
from the BVCA. This will ensure that the panel is in a position
to operate objectively and to effectively implement the "comply
or explain" principles set out in the guidelines.
The appropriateness of the proposed level and
type of disclosure for the various stakeholders in private equity-owned
The private equity industry has very high reporting
standards with respect to the information that it provides during
due diligence and subsequent to an investment by a Limited Partner.
The guidelines effectively extend the reporting
requirements of larger private equity-backed companies and will
result in greater disclosure to employees and other interested
We believe that these new requirements are appropriate
and will contribute to making private equity both more understandable
The enhanced reporting by the BVCA will also
contribute to improving the overall understanding of the private
equity industry. Reporting should focus on demonstrating the "value
creation" of the private equity industry as a whole and the
role that it plays in the broader UK economy.
Proposals for a respected capability for providing
comprehensive, industry-wide data on the private equity industry
It will take time for the BVCA to build the
additional capabilities to deliver the quality of data that is
required under the guidelines. We believe that the appointment
of E&Y to collect detailed data on larger private equity-backed
transactions is a welcome initiative, although more will need
to be done to achieve the objective of comprehensive, independent
and respected data for the industry as a whole.
The private equity-owned companies to be covered
by the code
We believe that the criteria set out under the
guidelines are appropriate as they capture what we believe are
the significant, larger private equity-backed transactions.
The tax treatment of debt and equity
In view of the significance of the financial
sector to the UK economy we consider that any change to the taxation
of equity and debt would need to be considered very seriously
as there is a real risk of damaging this important sector. Historically
most countries have taxed debt and equity differently and although
a small number of countries have recently introduced provisions
restricting tax relief for some interest costs, the structures
of their economies are different to the UK's and it remains to
be seen what the economic impact of such a change will be.
The Memorandum of Understanding between the BVCA
Currently there are three MOUs in existence
between the BVCA and HMRC: an agreement in 1987 and two in 2003,
one covering carry and the other manager's equity.
The 1987 agreement was instrumental in making
the UK an attractive location for basing a private equity business,
leading to the success of the private equity industry over the
past 20 years. We shall however focus our comments on the 2003
MOU covering carried interest.
The 2003 MOU does not change the legislation
but does set out a safe harbour method of valuing the initial
award of carry. This gives certainty to executives who acquire
the carry that they will not be faced with an upfront income tax
charge and also avoids HMRC having to find the additional resources
to negotiate values of carry for many different funds at potentially
several different times.
The MOU has been helpful in avoiding the need
for negotiations on value with HMRC each time carry is acquired
by a participant and we would be concerned if this safe harbour
was no longer available due to both the additional administration
burden that it would create both for private equity businesses
and HMRC and also the inevitable uncertainty that will arise in
the tax affairs of carry recipients.
Options for further reforms of the shareholder
debt and employment-related securities
The Committee has accepted (paragraph 91 of
its interim report) that there is no special tax regime for private
equity in respect of interest relief. Having said this, the private
equity industry is now potentially at a disadvantage when compared
to trade buyers, such as companies. For a corporate acquirer the
transfer pricing/thin capitalisation rules apply to both the acquirer
and the target entity combined hence giving the opportunity to
use the combined resources of both to arrive at a higher debt
capacity to fund an acquisition. A private equity buyer on the
other hand, can only rely on the target company's debt. It is
therefore possible for a corporate acquirer to fund the entire
acquisition price with debt although the effects may not be apparent
from the filed accounts of the target since the debt could be
put elsewhere in the corporate group.
As a result we consider that no specific private
equity provisions are needed and instead any changes should focus
on levelling the playing field between private equity-backed companies
and corporate groups.
The employer related securities regime is strict
by international standards, although similar to the US provisions.
The basic principle behind the rules is that, provided someone
has paid market value for an asset, then the future growth in
value of that asset should not be considered to be employment
income, provided its value is not subsequently manipulated. This
is a fundamental tax principle and one that should not be altered.
The appropriateness of the tax regime for private
equity, in the light of the recent changes to capital gains tax
The change to capital gains whilst unhelpful
for the private equity industry did at least demonstrate that
the taxation of private equity returns should not be treated differently
to other returns of the same nature. The change, however, is unhelpful
because it puts the UK tax rate at a level above some of the key
European countries, particularly those which are keen to attract
private equity businesses. The impact on the climate for entrepreneurs
is also of concern, as they are the people who grow and add value
to the businesses in which we invest.
Why investors make different demands of public
companies compared with private equity owned companies
The difference between a private equity investment,
compared to an investment in public equities, is the degree to
which private equity, as a form of active ownership, engages with
the management team of an investee company to agree a value creation
plan to deliver returns to shareholders. The private equity investor
will typically sit on the Board of the investee company, have
access to monthly management accounts and be in a position to
influence strategic decisions and key appointments.
This level of engagement gives the private equity
investor a much better understanding of the investee company,
its prospects and performance with the result that the private
equity investor is in a better position (relative to a public
equity investor) to make decisions with regard to that investment.
It also means that the private equity investor better understands
the risks that may impact an investee company and results in the
private equity investor placing different demands on an investee
The implications of private equity-funded takeovers
for company pension funds
There is no legal difference between a private
equity funded takeover and "other" types of takeovers.
Therefore there should not be any implications for a company's
pension fund whether the takeover is private equity or non private
Market abuse and conflicts of interest in private
Market abuse relates to the trading of publicly
listed securities and would probably be most relevant in the case
of public to private transactions. As regulated investment companies,
we are not aware of any greater risks of market abuse from private
equity than potentially from other investors in listed securities.
Although there may theoretically be a risk of
conflict of interests between a private equity investor and its
LPs, we believe that the industry manages these potential conflicts
well through, in particular, the investment agreements that are
put in place between private equity investors and LPs. Conflicts
of interest are explicitly dealt with in these investment agreements
and, importantly, remuneration structures are put in place to
reinforce an alignment of interest between the private equity
investors and LPs.