What do you do when you and your product are under constant attack, when outsiders are forming an orderly queue to damn your industry in the global media, and when regulators and legislators are arraying their forces to constrain you?
One option might be to turn to your many satisfied customers for backing. But as executives at buyout firms have discovered, the overwhelming majority of limited partners have remained silent. Instead of glowing testimonials, all the general partners have heard is a resounding silence from the LP base, punctuated by the occasional shout of support from select institutions.
Where is the private equity industry's Victor Kiam, the legendary president and chief executive of razor manufacturer Remington Products? He was a man who lived the brand and became his own advertising slogan when he proclaimed: “I liked it so much, I bought the company.”
Private equity has had its fair share of investors who liked it so much they bought shares in the management companies of leading private equity groups. But ever since the industry has had to deal with the public relations crisis now engulfing it, it has been short on champions in its corner willing to speak up publicly. “Limited partners, especially pension funds, are nervous about getting too far in front of the issues facing the industry at the moment,” observed Marc St John, head of investor relations at CVC Capital Partners, during a panel discussion at the European Private Equity and Venture Capital Association last month in Rome.
There are good reasons why limited partners do not seek the limelight in the current climate. Many institutions lack both the resources and the experience to deal with the media. Moreover, pension funds in particular often feel that they have little to gain from being publicly associated with the activist approach to value creation that private equity embraces.
There have been exceptions. In Europe, Danny Truell, chief investment officer of UK medical charity Wellcome Trust, has made the most robust LP intervention on behalf of private equity so far. In a recent letter to the Financial Times, he reminded the unions and other critics that without the returns from its long-standing investment in private equity, Wellcome would not be able to fund valuable medical research.
Then Nicholas Ferguson, chairman of UK private equity investor SVG Capital, stepped up and in a fell swoop discovered why so many investors have been reluctant to defend what is often the best performing asset in their portfolio.
In an interview with the FT published on June 4, Ferguson said he was a fervent defender of private equity's role in the economy. Indeed, he has been an advocate for the asset class for years.
However, Ferguson, whose firm SVG is the largest investor in funds advised by European LBO group Permira, was also quoted as saying: “Any common sense person would say that a highly-paid private equity executive paying less tax than a cleaning lady […] can't be right.”
Ferguson was referring to current tax rules in the UK, under which the money that private equity executives earn from carried interest is treated as capital gains. Taper relief rules allow the tax on this to be reduced from the top rate of 40 percent to as little as 10 percent, while any investment losses can also be offset against this rate, potentially further reducing the tax bill.
Ferguson argued any policy change must avoid “throwing the baby out with the bath water”.
The FT, however, focussed on the cleaners in a headline on its front page – with devastating effect. Coming from a leading industry figure, who has also served as chairman of Permira predecessor Schroder Ventures, the comment was succour to the industry's legion critics.
It provided live ammunition to trade unions, political opponents of the industry and other competitors who have argued that the private equity industry enjoys an unfair advantage in the current tax system. Less than a fortnight after the Ferguson interview was published, Peter Linthwaite, chief executive of the BVCA, was forced to resign after bearing the brunt of a brutal parliamentary grilling into the tax issue on June 12 in London.
Rod Selkirk, chief executive of Hermes Private Equity, whose firm participates in private equity as both general and limited partner, says: “That's the irony. For an informal group of investors set up to help make the case for private equity, one comment has done untold damage and completely diverted the attention away from the economic impact of private equity and its contribution to building a world class financial services sector [in the UK].”
Ferguson declined to comment for this article. His comment has baffled and infuriated many in the industry, but Selkirk blames neither him nor the BVCA. He says: “I don't think anyone could have predicted the extent to which [taxation of carried interest] became a political issue. There is no lack of transparency on tax and never has been. It isn't secret that capital gains tax tapers to ten percent on a business asset. Private equity has been complying with tax laws introduced by this government and yet is now being criticised for this.”
He does however think the onus for action rests more squarely with the GPs than with their investors. He says: “Every single firm has to stand up. Private equity is legitimate but so is the public interest in what private equity firms do and they to accept accountability. As it is, I don't think all firms promote their case as well as they should.” Selkirk believes the UK firms have for too long hidden behind the BVCA, allowing the trade association to bear the brunt of the criticism.
“Banks do not rely on their industry association to do their PR. Individual firms need to be accountable for their own actions and profile,” he says.
WHAT LPS CAN DO
David Currie, head of Standard Life Investments Private Equity in Edinburgh, believes investors can offer a useful portfolio perspective on the levers pulled by firms to create value. He says: “We know from our own portfolio the real value add is not just about financial engineering. Two thirds of the return is from improving a company's profitability.”
Currie says investors can help communicate the positive effects of private equity in helping businesses perform better, often by doing the tasks that “quoted companies sometimes did not have the stomach to do”, such as cutting jobs in order to restore a company's financial health.
For many institutional investors, it is irrelevant whether a company is public or private because they back both forms of ownership. It is a point Selkirk thinks his fellow investors should also make clear.
In the final analysis, what really counts are the returns and who ultimately benefits. Says Currie: “The majority of pension funds are pretty savvy and enjoying the returns, which for some prop up the rest of the plan. They are thankful to have the performance.”
For Selkirk, this is the reason why LPs should get involved in defending the industry: “The case has to be made that the returns are good and that is a job for investors. And by the way, the private equity firms are intermediaries, sure they get fees and carried interest, but the real beneficiaries of the returns private equity generates are the postman, the teacher and often union members.”
Given the current pressure that private equity is under, it will take courage for limited partners to articulate their support for the industry in public. But if more investors do muster it, public perception of the asset class may finally begin to improve.