Defending private equity

It’s only just over a year since the UK’s Treasury Select Committee grilled some of private equity’s most senior figures about the way they conduct their business, accusing them of tax dodging and destroying jobs in the country’s best known business names. It was an inevitable result for an industry that, on the one hand had become highly successful, high profile and was starting to touch the lives of most of the British population in one way or another as long familiar names such as Boots were being taken private, yet on the other had failed to engage with anyone beyond their immediate stakeholders – their LPs and portfolio company management.

Observers of the industry may have seen it coming, but private equity didn’t and its response was less than convincing.

The Walker Report, put together to address some of the concerns surrounding the transparency of private equity, took some of the heat out of the debate. “There were some legitimate concerns voiced during the media and union storm,” says Hamish Mair, director and head of private equity at F&C Investments. “They surrounded the fact that, technically, private equity did not have to disclose much information about the companies they were buying and when you’re talking about very large companies that are important to the UK economy, that needed to be addressed. The Walker Report did that. It was designed to take that issue off the agenda.”

Fast forward to today and private equity has remained largely out of the headlines. The media has other areas to focus on, such as the credit crunch, but that doesn’t mean private equity can relax. There is every chance that, with economic conditions taking a turn for the worse in most developed markets, a high profile private equity-backed business will go bust or default on the leverage put in as part of a buyout funding.

Redundancies and weakened businesses do not make good headlines for private equity, but they will make great stories for journalists and trade union officials, some of whom will be looking for an opportunity to take another shot at the industry. “There is a risk of this happening again,” says Mair. “I’m not convinced that the debate last time made clear what private equity contributes to the economy.”

Andrew Sealey, managing partner at Campbell Lutyens, agrees. “The issue has not gone away,” he says. “In the event that a company defaults or goes bankrupt, it’s not unlikely that private equity will be made the scapegoat and there is a reasonable chance that a high profile name gets into trouble – probably driven by the general economic climate, but exacerbated by the financial structure. Private equity has been bashed on the way up and will probably be bashed on the way down.”

We’ve already seen an inkling of the kind of tactics unions may employ. In the Grangemouth oil refinery dispute earlier this year, which centred around current and future workers’ pension rights, Unite chose to mount a personal attack on the owner of parent company Ineos, Jim Ratcliffe, for his private equity-style approach to the business. “I think the unions were trying to use the private equity tag to build public sympathy for their cause,” says Mair. “It was used to distract the media and the general public from the real issues.”

GPs and the industry bodies should be better prepared next time around. The BVCA has regrouped itself with a new chief executive, Simon Walker, who has served on Downing Street’s Policy Unit. EVCA has also been working to explain private equity’s contribution to the economy and to dispel some myths about the industry. And GPs have been busily recruiting communications professionals to help them put forward their message to the wider world. “The industry was taken by surprise with the backlash last time around,” says Sam Robinson, director of SVG Capital. “But private equity has already been through the wringer – it had to go through a steep learning curve, and that means it is better prepared and has its answers rehearsed. Firms also now realise that they have to engage with the media.”

On the offensive

But many believe that, in the spirit of partnership, limited partners have a communications role to play, too. Last time around, GPs were left pretty much on their own to defend the industry. Some LPs felt that GPs had got their just desserts for charging high fees and carried interest and so were unlikely to act as private equity’s champions; others just kept their heads down. The exception was Danny Truell, chief investment officer of The Wellcome Trust (and brother of Duke Street Capital co-founder Edmund Truell), who wrote an open letter to the Financial Times explaining that private equity had an important role to play in providing investment returns to fund the trust’s research.

So would it be any different next time? In many ways it will be harder for LPs to stand in defence of the industry when things are tough. “To date, the criticisms of private equity have generally been fuelled by jealousy about how much the next guy is making,” says Sealey. “That’s easily defensible and we should have seen more GPs and LPs making the point that it’s the pensioners and the holders of insurance products that benefit from private equity’s success, but that was missing last time. If there is a further storm because financial structures have caused businesses to go down, it’s harder to defend and it gives journalists plenty of material from which to make sensationalist stories.”

Yet it seems as though many LPs are now supportive of the idea that they should be involved in the debate. “LPs have the same responsibility as GPs.” says Robinson. “We believe that private equity has a benefit to society and I think it’s up to us and to other LPs to help get that message across. As a fund of funds, we can explain it to potential clients in a way that they can then explain to the people who pay into their pension for example – the average man on the street is benefiting from private equity. It’s a powerful message.”

Mair agrees: “LPs can state clearly that they have benefited from private equity. The idea that what the industry does is at the expense of the ordinary man in the street just doesn’t fit with the facts. Most people don’t realise that some of their savings are in private equity and that they have benefited from it. LPs should be able to make that case strongly.” Indeed, if it had been made clearer to union officials that their retirement benefits, and those of their members, depended in part on the returns of private equity, they might have behaved a little differently. And the people best placed to make that fact known would have been the institutions that invest on behalf of these current and future pensioners.

Another point that wasn’t made clearly enough last time round, but which should have far more resonance now is the alignment of interest between GPs, company management and the company’s fortunes. At a time when shareholders, pension funds and bank customers are all feeling the fall-out from the credit crisis while the bankers responsible reap massive bonuses, the idea that private equity executives have their own skin in the game and are only rewarded on good performance should frame the industry in a better light.


Of course, not all LPs are queuing up to join the debate through sheer altruism. There is a very real fear that if private equity retains a reputation for asset stripping and destabilising economies while being secretive about what it does, there will be heavy regulatory consequences. Certain members of the European Parliament are calling for tight regulation of private equity and hedge funds, for example. LPs would clearly be affected if such measures were adopted. “GPs, LPs and industry bodies need to put forward a coherent message making clear what private equity is about,” says Mike Powell, head of alternatives at Universities Superannuation Scheme. “We take the view that unless we work together and adopt a unified voice then the current self-regulatory environment will turn into a heavily regulated one and that’s not in anyone’s interest.”

One body, EVCA, is attempting to get LPs involved. “The EVCA board would like to see LPs further engaged in defending the industry,” says secretary general Javier Echarri. “They should be coming up with their view of how private equity fits into their overall portfolio.”

The body has been discussing how best to help LPs. “We understand that LPs don’t want to be criticised with regards to their responsible investment strategy – that is fair enough,” says Echarri. “But LPs do have a role and there is a greater awareness of that now but they are very conscious that they don’t necessarily know which space to defend and they don’t have ready-made messages. That’s where we can help.”

He points to the fact that some LPs have been presenting to the European Parliament hearings on whether and how the industry should be regulated. “They have put up a very strong defence of private equity,” he says. “That shows there is a greater willingness to engage in the public arena.”

LPs clearly have a role to play in fighting the industry’s corner – if only for the sake of their constituents – and there does seem to be a greater awareness among some of the need to stand up and be counted. USS is one institution that believes LPs could be more involved on a practical level. “We are very supportive of the Walker Report, but we think an opportunity may have been missed by not having more involvement from LPs both, prior, during and following the review,” explains Dan Summerfield, co-head of responsible investment at USS. “Having an LP on the Walker oversight board would certainly help matters. Investors should have a voice on this as well.”

But even where LPs don’t feel they have a role to join the debate publicly, there are other ways in which they can help bring about a greater understanding of the industry and prevent some of the more dogged attacks on private equity. USS believes that better reporting is key to this. “We have been working closely with GPs to ensure they understand our views on the benefits of improved transparency and disclosure that do not compromise the private equity business model,” says Summerfield.

“As part of our due diligence, we also look at how GPs address issues such as corporate governance and environmental risk management. We believe that such an approach presents significant benefits for both the limited partners and general partners in terms of generating increased value, reducing risks and protecting the reputation of the investor and the manager.”

It’s only a matter of time before we see another attack on private equity – it’s in the interests of everyone involved, including the LPs, that when it happens, a few lone voices aren’t left to face the storm. The consequences, otherwise, could be grave indeed.