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Peter Linthwaite, BVCA chief executive

The private equity market is transforming the industrial landscape. Two years
ago, 3i’s then finance director Michael Queen told an ICAEW conference that
there probably wasn’t a company in the bottom half of the FTSE-100 index that
couldn’t be taken over by a private equity group.

The last few years have seen airports group BAA swallowed up by an investment
consortium led by Spanish construction group Ferrovial, while Canary Wharf plc
has been taken private. And National Grid Transco has sold off huge chunks of
its gas network to financial buyers.

Around 20% of the UK private sector workforce is employed by private
equity-backed companies.

(To declare an interest, VNU, the Dutch-based company which owns Financial
Director, was acquired by a private equity consortium earlier this year – and a
further sale of the magazines division to another private equity group cannot be
ruled out.)

As for finance directors, the private equity space looks better paid and
lower profile than the quoted company sector, with less compliance burden and
more operational elbow room. Headhunters are being deluged with CVs from FDs and
other senior managers looking to enjoy more money and less limelight than in the
public company arena.

Finally, in November, the Financial Services Authority issued a discussion
paper looking at the risks and regulatory environment of the private equity
industry (see page 41).

So it seemed a good time to catch up with Peter Linthwaite, the chief
executive of the British Venture Capital Association – the trade body that
represents around 95% of the private equity market players in the UK. This
immediately raises a question about nomenclature, though there is a deeper issue
than that: how, we ask, would Linthwaite describe the paradigm shift in the
industry’s strategy over the past ten years or so that’s gone alongside the name
change from ‘venture capital’ to ‘private equity’?

“It’s better to start with definitions,” he says. “Private equity covers the
entire spectrum of equity investment in unquoted companies. Venture capital is a
sort of subset of that covering the early stage. Often the two4 are used
slightly interchangeably.” As for the BVCA, despite its name, Linthwaite insists
it represents the entire spectrum, “from companies investing in very early-stage
investments, technology, university spin-outs – right through to those dealing
with some of the very large and high profile buyouts you see in the newspapers.”

Big money
The phrase ‘venture capital’ has been regarded as something of a misnomer for a
decade or more. For years, the industry has been open to criticism that the big
money is drawn into big ticket, lower-risk, late stage deals – buyouts and
buy-ins, in other words, rather than true, high-risk, early stage ventures.

Today, it’s still true that there’s a kind of 80-20 rule in operation: a
great number of deals involve an investment of £1m or less, but in terms of the
weight of money, the data goes the other way. Linthwaite insists that the BVCA
represents the full spectrum of the industry – even if the top end of the
business is reaching into the stratosphere, in terms of deal size. (He ducks the
question as to whether a name change is on the cards for the BVCA to reflect its
all-encompassing approach to private equity, though he does admit that such
matters are kept under review.)

But while the investment profile of the BVCA’s members is still very much
orientated towards what might be called ‘change of ownership of existing
businesses’ rather than expansion capital or new ventures, it’s also true to say
that the heavy end of this business is now regarded as being significantly more
risky than it used to be – hence the FSA report which highlighted a number of
potential risks in the industry.

Linthwaite makes two points: first, he says, the FSA refers to potential
risks – not actual. Second, while the FSA discussion paper raises questions
about the regulatory regime governing private equity, Linthwaite notes the
conclusion that the FSA’s “current regulatory architecture is effective,
proportionate and adequately resourced”.

“We are the leading centre of private equity for Europe and it is a great
British success story that it’s grown from a cottage industry to what it is
today,” Linthwaite says. “When you see this report in the whole, what you have
is a report that recognises the benefit of the industry, the importance of the
industry as a capital market.”

But what about the risks identified in the report? The fears about huge,
leveraged deals, for example? “There are some potential issues but as yet those
are issues not just for the private equity world, they are issues that involve
the deals we get involved in – and, therefore, it affects banks, public
companies and advisers. These aren’t risks specific to private equity, but
they’re risks, obviously, when private equity is operating particularly in the
larger deals.”

This seems a far too subtle distinction, but Linthwaite adds that the banking
sector’s £45bn-odd exposure to private equity is “a drop in the ocean” compared
with total bank lending to the private sector of around £1.2 trillion. “In the
context of the whole banking system, [exposure to private equity deals] is very
small. Again, as the report said, there is not, here, a risk to the banking
sector. There is probably, as with any business, a risk for an individual
business, potentially, but the key thing is the economy.”

Value creation
One of the biggest changes in the industry is the way it has shifted at the
big-ticket end from a ‘management buyout’ orientation to a private equity
‘buy-in’ deal, with investors often hand-picking their own management team
before they initiate the transaction. “To keep achieving the very good returns
the industry shows, there’s much more weight placed on adding value to
businesses to develop sustainable, long-term value creation,” Linthwaite says.
“And for that, you really do need to understand the business very well and make
sure that you have in place the right strategies to achieve those objectives.
Perhaps you could say 20 years ago that there was a bit more low-hanging fruit
to pick. Nowadays, you need really smart management and that sometimes comes
through the private equity houses bringing in teams they know. I think it is
just another example of a maturing and more sophisticated industry.”

Corporates have complained in recent years that private equity buyers can use
financial engineering to enable them to outbid trade buyers in the acquisition
stakes. Whether or not the corporate sector has any right to feel unfairly
outgunned, private equity groups have certainly added an extra element of
competition that has kept vendors happy. Linthwaite says the evidence is sketchy
as to whether private equity buyers actually are outbidding trade players, but
one big change is that the sector is much more proactive towards deal-doing than
it used to be. “It now tracks more businesses; it doesn’t wait for the deals to
come to them to be introduced by advisers. Because there’s more industry
specialisation now, they already know the businesses in their target markets and
they’ve already identified the management teams that they rate as being good,
high quality. They are already developing strategies for these businesses.”

But Linthwaite insists that, far from the traditional perception of private
equity investors being asset strippers and cost-slashers, the emphasis now is on
improving acquired businesses, creating sustainable value. “Ultimately, the
returns from private equity come from flip-selling our investments [to another
private equity investor] or floating them on the stock market,” he explains. “To
do that, and to show appreciable increase in value, one has got to show that
you’ve built something that’s better than it was before, better run, better

The BVCA’s pre-Budget statement submission to the Treasury in October says
that, over the past five years, private equity-backed businesses saw sales
growth of 9% a year, compared with just 1% for FTSE-100 companies and 2% for
those in the FTSE-250. Exports by PE-backed businesses grew 6% a year over the
same period, while investment grew 18%, compared with national averages of 2.2%
and 1.1% respectively.

But perhaps now the correct accusation is not that private equity investors
are too risk-averse, but that they are too hard-charging, too demanding, too
focused on rapid growth. Since conducting our interview, we learned of a maxim
in the private equity trade that says, if you make love nine times a night the
baby will arrive in just four months. Linthwaite counters that, if the investors
are demanding, it’s not something that comes as shock news to the management
team the day after doing a deal. “The process of doing a deal is the culmination
of an awful lot of research and work and the formulation of a business plan that
management buys into, the private equity house buys into and the bank buys into
if there’s debt funding as well,” he says.

Getting a buzz
For FDs and other managers considering getting involved in the private equity
world – whether by being headhunted out of the quoted company world to run a
private equity-backed business or even by executing their own buyout – the buzz
is certainly there to be had. “Many of the management teams one speaks to feel a
greater sense of empowerment when they’re being backed by private equity,”
Linthwaite says. “They like the ability to sit down with all their shareholders
at a board meeting, make decisions, implement policy, implement strategies. They
find it a huge relief.

“With that empowerment, though, comes responsibility and there is absolutely
no question that a private equity-backed deal there is no hiding place; you are
answerable. Once you’ve made the flip, it’s your business. Private equity is
there to help on the strategic direction, but you are running that business.
It’s a quite interesting psychology when you see how people react under
different pressurised circumstances,” he says.

Still. Nothing ventured, nothing gained…

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