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Editor’s letter: Public interest in private equity

Andrew Sawers

First, a declaration of interest. In February, the publishing company behind
Financial Director was acquired by Incisive Media, a B2B magazine group
that exited the stockmarket when it was taken private by the large and
long-established private equity group Apax Partners. I mention this in case you
think that my experience of private equity owners in any way colours what I’m
about to say.

The private equity arena has received a lot of bad press in recent weeks.
Some of it may well be justified, though I would argue most of the mud that
sticks probably relates to individual companies rather than the financing sphere
itself. So whatever the strategies at organisation such as the AA or Saga may be
– or, for that matter, the logic of bringing two such groups together in a
merger – is really an issue for their management, their customers and their
owners. It’s not difficult to think of customers of quoted companies,
family-owned businesses or even mutual organisations that have had cause to
complain about their treatment, but it has got little to do with the ownership
structure of such businesses and more to do with whether they are making clever
decisions. Private equity certainly has no monopoly over disgruntled customers.

The tax issue is interesting, as private equity groups typically throw more
gearing at businesses than most quoted companies would regard as healthy or
prudent. Interest on the debt burden is tax-deductible, true enough. But three
things happen as a direct result of that. Firstly, it seems to me that if the
interest payment is tax-deductible, then some lender somewhere has taxable
interest income: gearing changes the locus of the tax burden so a more holistic
approach would seem to be necessary.

Secondly, the interest burden focuses the corporate mind on servicing the
debt and growing the business: you do not want to backslide and run into
default, so there’s a vibrant emphasis on creating the cashflow to stay out of
trouble. And sure enough, the statistics seem to show that private equity-backed
businesses outpace their listed company counterparts.

Finally, if the tax effect of gearing is to roll up annual profits into
lightly taxed capital gains, then surely that means that it is private equity
that has a longer-term, value-creation agenda, and not the short-termist,
shareholder appeasement that can be found in the earnings-oriented public arena.

It seems inevitable, however, that one consequence of all the hoo-ha is that
the ‘governance-lite’ regime of private equity will change. There will
unquestionably be demands for more transparency so that stakeholders have a
clearer picture of what is happening. This may even lead to a stripped down
Combined Code, compelling private equity-backed businesses and their financiers
to jump through more hoops in an attempt to ensure that the right deal-making
decisions are being made in the right way, and for the right reasons.

In many ways, this would be a shame. After all, Britain is blessed with a
regime that regards the market as the best regulator – and nowhere is that
regulator tougher than in private equity.

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