Increasing regulatory pressure is driving new boardroom mindsets in companies across Europe. In the UK, the government is proposing measures to give directors and auditors the right to place limits on their liability with individual companies. As the law currently stands auditors are 100% liable if a company fails and they are unable to cap their liability. What the accountancy firms feel is that they should be able to limit their liability by contract and it should be proportionate. The Department of Trade & Industry hopes the safeguards will remove a big disincentive to people joining company boards and will improve corporate governance. But what implications might this have on the private equity industry? Angela Sormani reports
Victoria Kershaw of SJ Berwin says: “One of the reasons these proposals have been made is the difficulty that the large accountancy firms now face in securing adequate insurance, and the related risk that yet another accountancy firm may be brought down by an Enron-style corporate collapse.” But the impact of these proposals, if they came into effect, on the private equity industry is uncertain. “A private equity investor, as with any shareholder in a company, would ideally want unlimited liability of the company’s auditor. There is also a concern that if auditors were allowed to cap their liability, the Big Four would be able to impose common liability caps on the market as a result of their dominance,” says Kershaw.
The auditing profession has long argued that current UK law is increasingly making the statutory audit unattractive as a business activity. The largest audit firms have proposed that section 310 of the Companies Act 1985 should be reformed to allow auditors to limit their liability by contract.
But the government does not believe it right to consider the adoption of proportionate liability solely in respect of the audit industry. Any introduction would need to be part of a major reform of the law of negligence. And this is a matter that clearly touches every industry and company in the UK.
On the one hand, if the DTI does not do anything to cap auditor/director liability it may be good news in terms of deal flow for the VC industry as small/mid-cap companies may be disinclined to list or remain listed on the public markets, as the cost and risks to directors may be seen as too high.
Rob Donaldson, of accountancy firm Baker Tilly, says: “This is quite interesting for the VC community. If the regulations remain as they are I think there may be a tendency for companies to be driven from the public markets into private equity type funding structures.” On the other hand, it may make the exit route for VCs more difficult. “You don’t want to see the public markets drying up,” says Donaldson.
Jon Moulton, at Alchemy Partners, warns: “If you look at the US, the rate of companies going private has risen sharply following Sarbanes Oxley and the number of quoted companies in the UK is also steadily declining. The more regulation, the less appeal there is to be a quoted company. Every additional regulation is another reason not to be a public company. Many professionals are reluctant to join a quoted company as a director because of the increase in regulation and governance.”
He adds: “It’s the relatively ludicrous regulations which are the problems, public companies certainly need some level of regulation, but it should be light and sensible. From an IPO viewpoint it is one of the reasons AIM has become more prominent; it’s lighter regulations have made it a more attractive exit route for private companies wanting to go public.”
A good corporate governance structure is important when it comes to exiting a business, in particular if the exit is a trade sale and the buyer is listed. The portfolio company will have to be integrated into a new system, and if a proper corporate governance regime is not in place this may cause problems. The purchaser could even walk away.
At a roundtable discussion at the recent European Private Equity & Venture Capital Association Symposium in Berlin, Josyane Gold of law firm SJ Berwin, Christopher Masek of Industri Kapital, and Jacques Lefèvre, chairman of the supervisory board for Industri Kapital portfolio company, Compagnie de Fives-Lille, discussed the implications of corporate governance from a private equity viewpoint in a session entitled ‘Who’s watching who?’ Josyane Gold asked whether the corporate shakeout had gone too far and whether or not a company should go private to escape corporate governance issues?
Chris Masek of Industri Kapital says: “An independent director is someone who doesn’t come from Industri Kapital and someone who isn’t reluctant to be a pain in the neck.” A non-executive director (NED) has the best interests of the company at heart. The GP, on the other hand as a major shareholder, may primarily only have the interests of his fund in mind. And so, for example, if the GP wants dividends from his stake in the company, but the non-executive director decides the company needs that cash, he can intervene to leave the money in the company.
An NED needs to be accessible when needed, which could be every day or every month. There are three different parties, each with three different responsibilities in the private equity world; the independent board members, the GP and the management. Jacques Lefèvre, chairman of Fives-Lille, Chris Masek and the CEO of Fives-Lille meet once a month. And if there is a clash between the shareholder and management, the NED can act as a go-between.
One of the beauties of private equity is being able to do things quickly and privately. “When you’ve too much red tape, you’re turning yourself into a public company. Our main concern as private equity investors is not to have too much red tape,” says Masek.
Victoria Kershaw says it remains to be seen what the outcome of the proposals will be: “There hasn’t been any response from the DTI since the consultation closed. It will be a controversial move to allow auditors to cap their liability. The government will need to ensure there is an adequate framework to ensure that the cap cannot be set too low. The government may also require that the arrangements be approved by shareholders, which may help to allay concerns of the private equity industry.” n