It is time, I think, to ask what private equity has done wrong. Last week’s three-ring circus in London, with members of parliament lashing senior figures from the industry, was further evidence that a lot of people are very cross. What about, exactly?
We must distinguish here between guilt by commission and guilt by association. Take retail groups such as Wal-Mart and Tesco. They are attacked for alleged specifics, such as maltreatment of the workforce or suppression of competition.
But they also act as lightning-rods for a much broader hostility towards big business and globalisation. The general public may not know much about business, but they know all about shopping. Tesco and Wal-Mart are under fire because they are under people’s noses.
So it is with private equity. The specific charges against it – the more intellectually respectable ones, anyway – concern tax avoidance and excessive use of leverage.
But there is also broad resentment of vast salaries and the same deep suspicion of big business. Private equity is also under people’s noses – ever since it started buying companies with household names.
Let us take the specifics first. In the UK, it is argued that carried interest – the profits made by selling companies – should be taxed as income, not capital gain. In the US, recently proposed legislation has the narrower object of applying the corporate tax rate when funds go public.
The industry’s response is divided and feeble. One prominent UK executive, Guy Hands, argued in this paper that the lower tax rate was a reward for risk, since executives put their own money on the table.
Mostly, this is plain wrong. Private equity firms act as agents, assembling equity from their investors and debt from the banks.
Only about 2 per cent of that equity, according to industry executives at last week’s London session, comes from the executives themselves.
But they typically take 20 per cent of the fund’s profits. That extra 18 per cent may be a just reward for hard work and expertise, but it is not the product of risk capital.
As to the industry’s threats to move offshore if taxes rise, forget it. New York and London are the world capitals of the industry and the usual cluster effects apply.
Ask yourself whether London’s hedge funds would be huddled together in Mayfair – the most expensive real estate on the planet – if they really thought they could be basking on private islands instead.
But the most serious charge against the industry is the damaging effect of over-leverage. Take Focus DIY, the UK home improvement chain, which has just been sold by two private equity firms to another for a nominal £1.
Focus is in effect bust and its bondholders are getting 40p in the pound. But the private equity firms are in profit on the deal, having loaded the business with extra debt two years ago and taken the proceeds out. And it is that debt, of course, which has dragged Focus down.
When the era of easy money ends, there will be a lot more of this. If the industry is seen to have profited by leaving a trail of ruined businesses in its wake, the reputational consequences scarcely bear thinking about.
All that said, let us return to the wider aspects. In much of this, private equity is the whipping boy. Its executives make vast sums, but hedge fund bosses make at least as much in their own quiet way. As for ruining businesses, public companies have been known to do that with the best of them, if not normally to their own profit.
But the issue is not whether the targeting of private equity is fair, but what it tells us as a symptom of public resentment.
The widening gap between rich and poor, in particular, might be regarded as a fact of life. But in investment terms, it can be classed as a geopolitical risk. And investors, as I have remarked in this column before, are not good at handling that.
Indeed, globalisation and free markets might be regarded as unstoppable forces. But they are nothing of the kind. They have been stopped before and the process has generally been nasty.
All this might seem a lot to land on poor old private equity. After all, its phenomenal rise in recent years has been largely due to the global tide of cheap money and that tide may even now be receding. In that sense, any official steps to restrain the industry will be shutting the stable door.
But so was Sarbanes-Oxley and that did not stop it doing damage. The latest credit cycle has been a wonderful jamboree for a lot of people and it will take luck and judgment if it is to expire without any backlash.
Private equity can help in this. Its executives are often urged to acquire the political skills of their public company peers. And so they must.
If not, so much the worse for the rest of us.
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