Credit where it’s due

Private equity was thrust firmly into the ­public eye in the UK throughout 2007. There were the protests at the Davos Summit in January, the Treasury Select Committee hearings in July and the publication of Sir David Walker’s ‘Guidelines for Disclosure and Transparency in Private Equity’ in November.

The industry has received an unprecedented amount of coverage in the popular press, coming under increased scrutiny and receiving a fair amount of criticism – much of it unwarranted. The press coverage has ­generally focused on tax issues and executive compensation issues, but the real story is – or at least, should be – the contribution that ­private equity makes to the UK economy.

In that respect, the 2008 British Private Equity and Venture Capital Association’s (BVCA) report on the economic impact of private equity in the UK, published in ­February, contains some good news.

The report is not a new concept (the 2007 edition is the ninth in the series), but it does make for interesting reading. The specific purpose of the report is to assess the contribution of private equity to the UK economy by examining the growth in employment, ­investment and profitability of private ­equity-backed companies. One of its key findings is that UK private equity-backed companies have increased the number of people they employ worldwide over the past five years by an average of 8 per cent per annum – a growth rate that compares favourably with FTSE100 and FTSE250 companies (at 0.4 per cent and 2.5 per cent respectively).

The report also found that companies that have had private equity backing account for around a fifth of UK private sector employees. According to the report’s estimates, private equity-backed ­companies outperformed the national average across the board over the past five years: exports grew by 10 per cent per annum (the ­national growth rate was 4 per cent); corporate investment rose by 11 per cent per annum (compared with 3 per cent nationally); and R&D expenditure rose by 14 per cent per annum (as against a national growth rate of 1 per cent).

Private equity-backed companies also identify other (non-financial) contributions from their private equity backers as important, such as management recruitment, strategic direction and financial advice. In fact, more than 90 per cent of respondents said that, but for private equity, their ­businesses would not have existed at all,
or would have developed less rapidly.

A misconception often fostered in the ­popular press – and partly based on the soon to be abolished 10 per cent effective rate of capital gains tax applicable to carried interest – is that the private equity industry does not shoulder its fair share of the tax burden. In fact, during the past tax year, private equity-backed firms collectively contributed £4.6bn in corporation tax, £13.8bn in PAYE and national insurance contributions, £11.9bn in VAT and a further £4.6bn on excise – a total of nearly £35bn in taxes.

The report concludes that private equity-backed companies continue to be a ­significant driver of the UK economy and its global competitiveness.

However, one aspect of the report that has come in for some criticism is the method by which the data on which the report was based was collected. In compiling the report, a random sample of 6,100 potential ­respondents were contacted, of which more than 1,000 responded.

It has been claimed the finding that worldwide employment grew by 8 per cent per annum over the five-year period to 2006-07 was misleading on the basis that, by only surveying private equity-backed companies still trading, the statistic did not take into account the significant number of private equity-backed companies that go into liquidation annually.

This problem, known as ‘survivor bias’, is well known when compiling snapshot surveys of this type. After all, a company that has gone into liquidation cannot respond to a survey. For its part, the BVCA points to the fact that the survey was carried out on its behalf by an independent research company using a methodology that is standard for surveys of its type, and also that the FTSE100 and 250 data against which the results were compared was gathered using similar methods.

Notwithstanding the criticisms levelled against the BVCA’s methodology, the report has an important role to play in aiding understanding of the impact that private equity has in this country.

There is a recognition across the private equity sector that the industry has an image problem. As mentioned earlier, the perception is that the popular press focuses too much on the perceived rewards available to private equity executives and not enough on the jobs that are created (and preserved) as well as the value created for investors, such as pension funds, by private equity investment.

The BVCA report can and should help private equity blow its own trumpet and correct some of the negative impressions that exist. It may well be that, as long as some private equity executives make many times the wages of those employed by the portfolio companies in which they invest, it is unlikely that the mainstream media can be persuaded to see the merit of any stories other than those about tax and salaries.

However, as the BVCA’s report says, ­private equity has a significant positive impact on the UK economy – and this is a message that deserves a hearing.

Stephen Gillespie is a finance partner in the London office of Kirkland & Ellis. He was assisted with this article by corporate associate Chris Kennedy