Private equity(06-07)

HC567–IPublishedon30July2007byauthorityoftheHouseofCommonsLondon:TheStationeryOfficeLimited£0.00HouseofCommonsTreasuryCommitteePrivateequityTenthReportofSession2006–07VolumeIReport,togetherwithformalminutesOrderedbyTheHouseofCommonstobeprinted24July2007TheTreasuryCommitteeTheTreasuryCommitteeisappointedbytheHouseofCommonstoexaminetheexpenditure,administrationandpolicyofHMTreasuryanditsassociatedpublicbodies.CurrentmembershipRtHonJohnMcFallMP(Labour,WestDunbartonshire)(Chairman)MrGrahamBradyMP(Conservative,AltrinchamandSaleWest)MrColinBreedMP(LiberalDemocrat,SouthEastCornwall)JimCousinsMP(Labour,NewcastleuponTyneCentral)MrPhilipDunne(Conservative,Ludlow)AngelaEagleMP(Labour,Wallasey)MrMichaelFallonMP(Conservative,Sevenoaks)(Chairman,Sub-Committee)MsSallyKeebleMP(Labour,NorthamptonNorth)MrAndrewLoveMP(Labour,Edmonton)MrGeorgeMudieMP(Labour,LeedsEast)MrSiônSimonMP,(Labour,Birmingham,Erdington)JohnThursoMP(LiberalDemocrat,Caithness,SutherlandandEasterRoss)MrMarkToddMP(Labour,SouthDerbyshire)PeterViggersMP(Conservative,Gosport)ThefollowingmemberswerealsomembersoftheCommitteeduringtheinquiry:MrDavidGaukeMP(Conservative,SouthWestHertfordshire),KerryMcCarthyMP(Labour,BristolEast),andMrBrooksNewmarkMP(Conservative,Braintree)PowersThecommitteeisoneofthedepartmentalselectcommittees,thepowersofwhicharesetoutinHouseofCommonsStandingOrders,principallyinSONo152.TheseareavailableontheInternetvia(includingpressnotices)areontheInternetat(Clerk),FionaMcLean(SecondClerkandClerkoftheSub-Committee),AdamWales,JonYoung,HarryMarinandAnnaLeach(CommitteeSpecialists),LisMcCracken(CommitteeAssistant),MichelleEdney(Secretary),TesStranger(SeniorOfficeClerk)andLauraHumble(MediaOfficer).ContactsAllcorrespondenceshouldbeaddressedtotheClerksoftheTreasuryCommittee,HouseofCommons,7Millbank,LondonSW1P3JA.Thetelephonenumberforgeneralenquiriesis02072195769;theCommittee’[e-mail]1ContentsReportPageSummary31Introduction5Ourinquiry5Scopeoftheinquiry52Theprivateequityindustry7Thesizeoftheindustry7Thegrowthoftheindustry7Typicalfundstructures8Ratesofreturn9Futureprospectsforprivateequity103Privateandpublicequitymodelscompared11Advantagesanddisadvantagesofprivateequity11Chainofownership12Investmenthorizon13Reportingrequirements14Incentives14Leverage15Jobcreationanddestruction16Pensions16Publicorprivateequity?174EconomicRiskandFinancialStability19Introduction19Marketabuseandconflictsofinterest19Leverageandeconomicrisk21Theincreaseinleverage21Theeconomicandcreditcycle22Covenant-liteloans23Excessiveleverage26Unclearownershipofeconomicrisk285Transparency30Transparencytothepublicandtoemployees30Independentdata32Alegislativeresponse?33Transparencytoinvestors33Thepurposeoftransparency33Competitionandthefeestructure34TheTUPERegulations352Privateequity6Taxation36Introduction36Taperreliefandcarriedinterest36TheMemorandumofUnderstanding37Taxtreatmentofdebtandequity38Taxdomiciliarystatus407.Conclusions41Formalminutes45Witnesses49Listofwrittenevidence50Privateequity3SummaryOurinquirywasundertakeninresponsetothegrowingsignificanceoftheprivateequityindustryintheUK(8%oftheUKworkforceisnowemployedinprivateequity-ownedcompanies),and,inparticular,totherisingnumberoftakeoversofverylargecompaniesbyprivateequityfirms.Wehaveconcentratedonthehighly-leveragedmanagementbuy-inandbuy-outsector.Ourreportisaninterimone.Weexaminetherespectiveadvantagesanddisadvantagesofprivateequityandpubliclimitedcompany(PLC)ownership,andconcludethattherearebenefitsandpotentialproblemsassociatedwitheach,andthatdifferentformsofownershipmaybeappropriateforacompanyatdifferenttimesinitshistory.Thereremainsadebateinthecaseofsomelarge-scaleprivateequitytakeoversabouthowmuchoftheprofitcanbeattributedtofinancialengineeringcomparedwithvalueextractionandcreation.ManyofourwitnesseshighlightedthedisadvantagesofPLCstatus.Weinvitemajorcorporateinvestorstore-examinewhytheirrequirementsofPLCsandofprivateequity-ownedcompaniesaresodifferent.Wenotetheneedtoensurethatcompanypensionfundcommitmentsaresecurelyfunded,especiallywhenchanges,suchasanincreaseinleverage,aremadetoacompany.Wenotethat,howeverextensivetheduediligenceconducted,higherlevelsofleveragearelikelytocreateadditionalrisk;thatthisbecomesmoresignificantthemoreimportanthighly-leveragedfirmsbecomeintheeconomy;andthatthetrendtowardsgreaterleveragehasoccurredduringaperiodofeconomicgrowthandstability,whichisnotguaranteedtocontinue.WethereforeurgetheBankofEnglandtoresearchthepotentialimpactofaneconomicdownturn,bothonhighly-leveragedfirmsandonthewidereconomy.WealsorecommendthattheFinancialServicesAuthoritycontinuestoseekassurancethatthebankingsystemhastheappropriatestru