"A refreshing addition to the world of think-tanks" Daily Telegraph, 18/10/2007
PROGRESSIVE views on ...
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PRIVATE EQUITY
Last updated: 26/03/2008
Attacks on the private equity industry are driven by envy, not sound policy analysis and should be resisted by government. The government's decision to increase taxes paid by private equity not only risks harming small business which were not the prime target of the taxes, but also to drive private equity business out of London to less hostile environments.
Until recently, few outside the finance industry were aware of the term “private equity”. However, the industry has been reluctantly thrust into the limelight by virtue of its success and the corresponding attacks by those envious of the industry.
Attacks on private equity appear to focus on the following issues.
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Lack of transparency |
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High profits |
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Low apparent taxes |
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Aggressive business practices |
These attacks are driven by a lack of understanding of this industry and envy.
Most businesses start off as private companies and some, if successful, seek listing on a stock exchange. The public listing provides many benefits, such as ease of raising additional investment and, for shareholders, the ability to realise profits made in their investment. In time the constraints of stock exchange listings may outweigh these benefits and make a company attractive for delisting and taking into the realm of private equity. These purchases are typically backed by a large amount of debt, which provides the opportunity for great profits, but also great losses.
Those complaining about a lack of transparency in private equity businesses are often concerned about the perceived loss of control over a “national brand” such as Boots. In many respects the private equity industry is paying for the success of marketers, who have sought to portray their brands as part of the family or at least the community – “someone who cares”. Combine this with the development of citizen shareholders over the past 25 years people feel an ownership of a brand and therefore lament the loss of perceived influence when a well known company ceases public listing. These understandable emotions on behalf of the public must be resisted by policymakers: Companies are owned by shareholders, not customers or unions. Directors of companies have a duty to maximise profits for shareholders and this means providing customers great service and value for money and this is best achieved with a happy motivated workforce.
One of the criticisms of capitalism has been the short-term nature of listed companies. Much of this criticism is weak – one only needs to look at the pharmaceutical or automotive industries who invest huge amounts in research and development in the expectation of profit in a decade’s time. However, there is an element of validity in the claim and private equity industry provides a valuable antidote to this weakness. Companies following a short-term strategy at the expense of the long term, can find themselves vulnerable to a takeover by private equity.
The benefits of moving companies into the realm of private equity can be seen by the strong long-term profits made by such businesses. However, it is just these profits that motivate the industry’s envy driven critics. Profits are what results when a purchaser and a seller engage in a transaction that makes both parties better off (why engage is such a transaction otherwise?). Such profits reflect not only increased wealth for the company, but also for its customers, suppliers and employees.
Much has been made of the apparent low tax regime enjoyed by businesses. This low tax environment has helped make the UK’s private equity industry the second largest in the world and accounting for 57 per cent of the European market. Many of the individuals involved in the private equity market could easily move their base from London and changing the advantageous environment threatens the wealth that the private equity industry brings the nation. Exports generated by private equity firms grew by 6 per cent p.a. in the five years to 2005/06 compared with a national growth rate of just 2.2 per cent. Any moves to harm the private equity industry will affect the wealth of the nation.
It is a mistake to believe that Britain will retain its dominant position in the world’s private equity market by keeping the status quo. Many nations look enviously at the benefits Britain gained from this industry and they are attempting to lure businesses away. The lower carried interest rates in Germany, Italy, France and Ireland have all been enacted since 2004. Certainly simplification of the British tax laws, along the lines of the Irish flat tax, would be beneficial by creating greater certainly and reducing bureaucracy.
Most of the concern about carried interest involves only about 180 individuals in London, the majority of whom are not resident in the UK for tax purposes. It is estimated that only 30 people would be directly affected by any change to the taxation of carry interest. Many of the remaining 30 would probably arrange their affairs to tax domicile themselves abroad as well. Any attempt at increasing tax on those few will probably result in less tax being collected by the British Government.
The government's announcement in the recent Pre-Budget Report that it will increase impose a flat capital gains tax of 18 per cent, an effective 80 per cent increase, will only harm Britain's strength in the private equity industry. As well, the increase will have negative consequences on many small business owners who were not the prime target of the tax increase. The government should be striving to improve the business climate in Britain, yet in this instance it has done much harm.
Private equity firms have been accused of aggressive business behaviour with negative consequences for employees and suppliers, but aggressive is a simply a pejorative term for competent. All businesses should continually reassess their relationships with all trading partners. Suppliers (those that complain the most tend to be private companies themselves) must deliver what the customer wants and their customers have no obligation to continue purchasing from them. Imagine if the public were required to keep purchasing from the same supermarket or pay higher prices, just because to move would be “unfair” to the supermarket? Ridiculous. Companies complaining about such competitive behaviour should get out of the business. As for employees, the allegations of layoffs and tough practices by private equity firms is false. The number of people employed worldwide by British private equity firms increased by an average of nine percent in the five years to 2005/06. This compares to five-percent to FTSE Mid-250 companies of five per cent.
Private-equity businesses are a legitimate part of the economy. Moreover, they provide a valuable service to the market an have an extremely positive effect. Current criticisms of the industry are motivated by envy, not objective analysis. Any attempts to increase regulation or taxes on private equity will have a negative effect on the British economy and should be resisted.
KEY POINTS
• Private equity firms create a lot of wealth in Britain
• They make UK businesses more productive
• They provide a long term focus for affected companies
• Britain faces strong competition for private equity businesses
• Britain’s current tax rates should be lowered rather than raised
• Private equity firms increase employment faster than publicly listed companies
• Increased taxes or regulation of the private equity industry will only do harm to Britain
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Typical rate of
taxation on carried interest:
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0% |
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10-40% |
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11-27% |
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12.5% |
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15% |
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18% |
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20% |
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23.5% |
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