The storm over 'locusts'

It's easy to envy vast personal wealth garnered by private-equity practitioners - but unproductive. Being filthy rich doesn't make them filthy.

by Richard Reeves
Last Updated: 31 Aug 2010

Private-equity firms have made the transition from invisibility to obloquy. Once the sector got big enough to gobble up household names like the AA and Birds Eye - and threaten high street regulars such as Boots and Sainsbury's - the world woke up to the fact that there was a new kid in the Square Mile. And that he was big, mean and ruthless. These companies are dubbed 'barbarians', 'asset-strippers' and 'locusts' by trade unions. The Treasury Select Committee is examining the way they are taxed, and the media herd is pursuing firms like Permira, Blackstone and KKR with something close to blood-lust. Private equity has gone, in the public imagination, from zero to villain.

But it's difficult to locate the precise source of the enmity. Part of the problem in the UK may be an instinctive dislike of activities with the prefix 'private' - whether it's health, education or even (as Gordon Brown discovered) dentistry. Privacy smacks of privilege. But specific charges thrown at the private-equity sector vary: they are tax-avoiders, they have no national or community loyalties, they lack transparency, they're short-termist and treat workers badly. In February, the industry held a conference in Frankfurt under the title 'Super Return'. The GMB union, its most vociferous opponent, held a desultory protest, on the grounds that super returns for investors mean P45s or worsening employment conditions for workers.

But not many of the charges stick. It's probably true that private-equity firms pay less tax than equivalent plcs, because they set huge debt against the books of the firms they buy - the interest on which attracts tax relief. But nobody has ever accused them of doing anything illegal. They simply do what most sensible firms and individuals do: they structure their finances to minimise their tax bill. And if the tax relief is removed, it will hurt not only these firms but debt-strapped manufacturing companies too.

The difference, of course, is that private-equity firms are footloose. If they can get a better tax regime somewhere else, they'll say goodbye to London. The picture on employment is cloudy too. It's certainly the case that a takeover by a private-equity firm usually prefigures job losses. Says Guy Fraser-Sampson, author of Private Equity as an Asset Class (Wiley), the first textbook about private equity for investors: 'Buyout is bad in that typically they proceed by rationalisation, which will mean job losses. They structure the deals financially so that they won't pay any tax, so you are reducing tax yield.'

But for private-equity firms, the business model of buyouts is to buy companies that they think can be improved on, make the improvements, and then sell for a profit. They are like property developers buying up granny's mouldy house, renovating it and selling on. The crucial point is this: if they want to sell for a profit, and if the people buying have an IQ anything above ground level, they can't destroy the value of the business. For private-equity firms to make their vast profits, the firms they sell have to be more valuable than the firms they bought. If they have fired all the best staff in a company and reduced the morale of the rest, who'll buy it?

Nor does the accusation of short-termism stick. The average length of time a stock is held in a plc is about 18 months; private-equity firms typically hold onto their acquisitions for a few years. Compared to stressed fund managers, who scrutinise company accounts on a quarterly basis and dump stock in a heart-beat, private-equity firms are leaders in long-termism. And it's possible for the managers of plcs to gut their companies ready for a sale from which they, with stock and/or options, will personally benefit.

Nonetheless, the reputation of private-equity concerns is under attack, and they are responding. They have met one of the chancellor's most forceful advisers, Shriti Vadera, to try to head off regulation. Some private-equity financiers are now the biggest donors to the Labour party. They have also formed a working group to look at their levels of financial disclosure. This may help, although having hard evidence of the billions that are being made by the billionaires whose money sits in the funds may raise levels of outrage still further.

It's vital to control one's own envy or distaste in this debate. For some participants, being filthy rich is enough to make somebody filthy. But there is no shame in wealth. And private equity is not the bogeyman stalking the news pages. This is not to say that there is no problem. A society is an ailing one if a handful of the super-rich can use their vast fortunes to reshape capital markets in such a way as to make themselves even richer, and hold democratic governments to ransom by threatening to jump offshore if they are subjected to the indignity of paying more tax. Inequality is bad for wellbeing, bad for civic engagement and bad for politics.

The vast wealth now being accumulated will cascade down to a new generation, who will have colossal unearned power and influence: a new aristocracy is in danger of being born. Higher personal tax rates and, most importantly, very much higher inheritance tax rates are the proper solution. Private-equity firms are both the result and cause of a level of financial inequality that is scarring our society. Private equity is being shot at - but it is only the messenger.

- Richard Reeves is director of Intelligence Agency, an ideas consultancy; e-mail:

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