Traces of transparency

What is not clear at this stage, however, as the industry sets forth to debate transparency and disclosure requirements is who wants what to be disclosed by whom and why they want to see more disclosure and what that disclosed information will be used for.These questions are expected to be posed by the British Venture Capital Association (BVCA) which has taken the lead in Europe. It recently announced details of its heavyweight working group that will set out over the next six months “to establish a review of transparency and disclosure in the industry with a view to forming a voluntary code or set of guidelines on a ‘comply or explain’ basis”.

The working group is chaired by Sir David Walker who is joined by a group comprising Sir Michael Rake, international chairman of KPMG; Adrian Beecroft, deputy chairman of Apax Partners; David Blitzer, senior managing director of Blackstone Group International; Anne Glover, chief executive of Amadeus Capital Partners; Robin Hall, managing Partner of Cinven; Baroness Hogg, chairman of 3i; Lord Hollick, partner of KKR; William Jackson, managing partner of Bridgepoint; Dwight Poler, European managing director of Bain Capital, and Rod Selkirk, chief executive of Hermes Private Equity.

Potential multi-billion pound private equity buyouts have obviously grabbed the attention of the wider public in the UK in recent months with specific media commentary that supermarket giant Sainsbury’s and pharmacy chain Boots Alliance are being targeted. Every UK consumer will know or will be aware of both of these brands.

The fall-out from another high-profile buyout completed by CVC Capital Partners and Permira in July 2004 is also fuelling a large part of the debate in private equity right now. Following the £1.75bn buyout of the Automobile Association (AA) – termed the fourth emergency service by a smart advertising creative some years back – the new owners have shed a proportion of the workforce, which the labour unions are unhappy about. The GMB Union in the UK says that 3,400 job cuts followed the buyout.

“The capacity of funds to do large transactions has increased and these investments are taking on a very high profile in their own right. We understand that there is a wider group of parties that are interested in knowing more about the activities of these investors,” says Peter Linthwaite, chief executive of the BVCA in London. “It’s about more than the employees and shareholders of a company knowing about it. It’s a coming of age for the industry.”

“I think it is fair to say the UK is pioneering this although it is an issue that is not just a UK issue,” he says.

The European Private Equity and Venture Capital Association (EVCA) says it welcomes the announcement by the European Socialist Group of the European Parliament debated on private equity and hedge funds in Brussels on March 29.

Beyond saying that it is open to debate and that it looks forward to addressing the “misconceptions surrounding the industry”, the EVCA is saying very little else on the matter.

Member of the European Parliament and Socialist economic coordinator Ieke van den Burg tells EVCJ that the European Socialists are concerned that aspects of private equity have a negative impact on the European economy. Her political colleagues are calling for debate about how the private equity & venture capital industry and hedge funds are affecting the economy at large.

The European Socialists have fundamental issues with the profits being derived from private equity deals. “The big bonuses for private equity and for investment banks,” says Van Den Burg. “They are successes that are not produced in the economy at large but only in the financial world.”

“The debate needs to be more specific, and focus more precisely on what more needs to be done to satisfy that legitimate interest,” says Simon Whitney, a partner at SJ Berwin in London.

“In fact, of course, this debate has been going on for decades: it is at the heart of the way that governments tax and regulate asset managers, investors and private companies, which is sophisticated and well thought through. The scale of private equity in recent years has inevitably thrust it into the spotlight; but many large companies have been owned by concentrated groups of investors for a very long time. Indeed, until comparatively recently, that was the dominant model in many Continental European countries,” he says.

The BVCA’s working group will set out to assess the adequacy of existing disclosure arrangements for investors and for the public in respect of private equity portfolio companies. It will also examine the clarity and consistency of practice with regard to valuation methodology and verification and to disclosure to investors of returns and fees.

The BVCA announced that their “intention is to establish a voluntary code of compliance which would ensure appropriately high standards of disclosure and valuation on a fully comparable basis, proportionate to the size and type of private equity business.”

Will the BVCA process focus on and lead to the need for more communications or more regulation? “It’s a little bit of both. It’s making sure that people who have a legitimate interest in companies are kept aware,” says Peter Linthwaite.

Defining exactly what the disclosure debate should focus on is going to be the key challenge for the BVCA working group and the debate in the European Parliament and in wider circles.

“We have mixed feelings about the debate, which is like a pendulum swinging backwards and forwards,” says André Jaeggi, managing director at Adveq in Zurich. “The debate is not about which fund has performed in a certain way, it is really that some people want to have an insight into company financing.”

“I don’t mind disclosing things that the unions are keen to see such as salaries. What I do not want to see disclosed is the various financing rounds. Do we really want to disclose these finance rounds and let competitors know every financing detail?” ask Jaeggi.

“It’s hard to argue against disclosure. I have never been in a position of denying information to anyone who has asked for it. The reality is if you want to find out how much I am paid, for example, you can easily find out at Companies House,” says Jon Moulton, managing partner at Alchemy Partners in London.

“I have been asking everyone from politicians, people in the UK Treasury and union officials what it is exactly that they want to be disclosed and no-one seems to be able to say what it is they want,” he says.

Limited partners in buyout funds, whether they are investing on behalf of large pension funds, insurance companies or for other investor groups are entitled to information about a particular company or a fund in which they have an allocation. And GPs say this flow of information is largely adequate to serve their needs.

“Investors get a quarterly report from us about each company, supplemented by further discussions which give them even greater detail,” says Ian Armitage CEO of HgCapital in London.

“Our reporting will give investors a good idea of a company’s management and leadership, its overall strategy, whether it is serving its customers well, quality of controls and risk management and its financial numbers. If you get all of these areas right then you more or less get disclosure right,” says Armitage.

Nevertheless, the way GPs report to their LPs is evolving as much as the industries in which they are investing in and the developments of the economies in which those industries are based.

“An LP will be told the gearing of an individual company. However, LPs rarely ask about the gearing of an entire portfolio of companies,” says Armitage.

“Fees should always be disclosed by a GP to its LPs. This is not always the case but it will become the norm,” he says.

Funds ranging from start-up venture capital firms to the large buyout funds generally agree there is some information of a commercially sensitive nature that should not get wide disclosure such as the precise strategy of a company operating in a highly competitive market.

Accordingly, disclosing too much about a company’s product or strategy could be detrimental to it. There is also increasing notion that investors should also be made more aware of confidentiality issues.

“In venture capital the financing structure is all pretty transparent,” says Antoine Papiernik, managing partner at Sofinnova Partners in Paris.

“We won’t give away confidential information about our life science and information technology companies, as most of them are based on patents. We are careful even in disclosing information to our LPs.”

“The type of equity that we use is very standard; there is no leverage in it. At the big buyout end the perceived problem is sometimes the lack of information and disinformation about how buyouts are run,” says Papiernik.

“Disclosure should be made to your investors but under a confidentiality agreement. Our industry has to draw a very clear line between what we can disclose,” says Jaeggi. “With all of our investors we are beginning to set up guidelines for confidentiality. It is really an issue to protect our investee companies.”

“In a classical buyout model, for example, there will be a portion of funds assigned to add-on investments. This could be damaging to an investor if these are disclosed,” says Jaeggi.

“If you really go for full transparency you might get to a situation where the company funded by private equity could be at a disadvantage compared with companies that are not funded by private equity,” he says.

Perhaps the very title Private Equity equates to ‘Clandestine Equity’ for some observers, but those involved in the industry generally agree that private equity and listed equity companies have to observe the same set of corporate governance rules.

“There is confusion about the role of a private equity firm and the board of the underlying portfolio company,” says Armitage. “Disclosure remains the responsibility of the board and management of the portfolio company. I’m not sure that a company needs to do anything more than is flagged in existing employment law, for example, when it comes to any downsizing.”

“We and our portfolio companies have the same duty of care to observe legislation as any other private sector company,” he says.

Whitney points out that the legal requirements are more or less the same for listed and private equity-backed companies. “In general, the rules governing quoted and unquoted companies are not different as regards the interests of wider stakeholders. Such differences in disclosure requirements and regulation as do exist are there to protect the more widely dispersed shareholder base in the quoted sector, and not employees or creditors. Companies are subject to strict rules that seek to protect those groups, and private equity-backed companies are – in that respect – in basically the same position as their quoted counterparts.”

Companies like 3i have long been used to reporting very detailed financial information and could be a kind of blueprint, some industry players are suggesting, for how large buyout firms report to a wider public audience.

“For us, being open and transparent has been a way of life because 3i has been a FTSE 100 company for the last 13 years,” says Patrick Dunne, 3i’s group communications director in London.

“One of the challenges in greater disclosure is to produce a situation that does not place too much more of a burden on a £50m buyout company compared to a FTSE 100 company,” says Dunne.

A couple of the key topics on the European Socialists agenda in late March are the tax treatment of loans from shareholders to investee companies and the exportation of profits out of the European economy.

“This is a shift in income distribution that goes in the wrong direction,” says Van Den Burg.

“Are profits really transferred to offshore locations?” asks Jaeggi. “You always have black sheep in an industry and it would make sense to have control over the black sheep.”

On the issue that tax exemption on loan interest payments is being given unfairly, Armitage says: “The idea that there is subsidy to private equity-backed firms is nonsense.”

He adds that in the context of the free flow of international capital that the private equity business is actually boosting the economies of the member states of the European Union as opposed to stripping it of profits.

“Lots of the money managed in London comes from investors based outside of the UK. Two-thirds of our clients are overseas clients and so our investment activities are producing significant export earnings for the country,” says Armitage.

Last year, Poul Nyrup Rasmussen, who is chairing a working group on hedge funds and private equity, stressed: “When even the US Congress starts to be interested in this dossier, a regulation at least for all relevant financial markets becomes conceivable. But we need not wait for the Americans. Europe ought to confirm its leadership in the domain of modern financial market regulation. That’s why the European Socialists will continue to deepen their reflections on this subject during the months to come.”

While the UK is clearly leading the investigation on how to manage transparency and disclosure, politicians in Europe say the focus will also soon extend to countries such as Denmark, Germany and the Netherlands.

As a brief aside, there is a view in European politics that the European Commissioner for Internal Market and Services Charlie McCreevy embraces alternative asset classes such as private equity and hedge funds without sufficiently addressing the potential pitfalls. Indeed, his many recent speeches on the subject of private equity do not warn of any impending economic crises because of its role in Europe (see http://ec.europa.eu/commission_barroso/mccreevy/index_en.htm).

The debate about private equity’s role in Germany flared up a few years ago and was then contained by the industry there when it focused on informed debate.

“The ‘locust’ debate in Germany was initially fuelled in 2005, albeit by short-term political motivations and questionable rhetoric, based on misunderstandings and selected disinformation,” says Jeremy Golding, managing director and founder of Golding Capital Partners in Munich.

But in Germany it was more a question of latent disquiet due to the relatively new nature of the asset class there, rather than unbridled criticism. Ironically, the concerns in the UK have now overtaken those in Germany and are no longer about latent disquiet but public outcry, he says.

“There should be calls for more education, public discussion and dialogue on the advantages of private equity rather than detailed regulated disclosure. Golding Capital Partners took on a ‘pioneering’ role for private equity in Germany, championing the asset class and trying to communicate its role in economic restructuring and growth, both with investors and in the public domain. Indeed, this has led to an increasing acceptance of private equity as a financing instrument in Germany. It would be ironic if that goodwill should be destroyed by another short-term politically motivated outcry,” says Golding.