Select Committee on Treasury Written Evidence

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 businesses

  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 parties.

  We believe that these new requirements are appropriate and will contribute to making private equity both more understandable and transparent.

  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 and HMRC

  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 company.

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 equity funded.

Market abuse and conflicts of interest in private equity transactions

  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.

December 2007

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