Labour finds Gordon Gekko
The private equity industry should be a little bit anxious this morning, as three candidates to be deputy leader of the Labour Party have expressed concern about how it operates.
The main concern of Alan Johnson, John Cruddas and Peter Hain appears to be job losses at companies like and which have been bought out by private equity funds.
And as I discussed yesterday, Hain is not a fan of the accumulation of vast wealth by those who work in private equity (and others among the new super-rich).
What would or could they do about all this? Well they could make it more expensive for private equity to buy businesses. The way to do that, they appear to think, would be to increase the cost of borrowing for them. And the way to do that would be to end the tax-deductability of interest payments.
They have correctly identified that private equity funds primarily use debt to finance their takeovers of businesses. But would it be technically possible to end the tax-deductability of interest only for private-equity buyouts. And if it weren't possible to ring-fence private equity deals, would it make sense to end tax-deductability of interest for all corporate borrowers? Few companies would cheer I think at the notion of paying more for borrowed money.
But there is a second issue which the Labour trio need to address. They would need to demonstrate that the cost-cutting - which includes job shedding - carried out by private equity isn't good for the British economy, however painful it may be for some employees of private-equity owned businesses.
There was a similar outcry against what were then called Leveraged Buyouts - but were essentially private equity deals - in the US in the 1980s. Remember the film and ? Well Cruddas, Hain and Johnson appear to think Gekko is alive, well and living in London's West End. And they may be right. But for all the furore about LBOs in the 1980s, there is little doubt that they helped to revive a US corporate sector that had become bloated and stodgy.
I am not a cheerleader for private equity. There are legitimate concerns about whether the pension funds upon which many of us depend have been under-invested in the better private equity funds, so have missed out on their super-normal returns, and whether those same pension funds have allowed private equity to buy some British companies too cheaply. But it is simplistic to say "private equity bad, public company good".
I'm 
°δ΄Η³Ύ³Ύ±π²Τ³Ω²υΜύΜύ Post your comment
I find it bizarre that you should mention private equity poses a threat to pensions, when it is the current government that poses the greatest threat to them by burdening them with a massive tax hike over the last few years.
Your story is a very, very old one dressed up in new clothes; that vast wealth and and privilege are great because when the rich enrich themselves it benefits everybody, yet when workers want to keep their jobs or ask for a pay rise or for a decent pension when they retire it is inefficient and unsustainable. Exploitation is the basis of the fat cat privileges of you and your rich backers.
The poor have no access to the media to propagandise like you can but we have the streets and the workplaces. You can be assured your vision of a world of war, vast wealth for a few and insecurity for the majority of the population is not one shared by working class people.
This is political grandstanding for the benefit of Labours newly rediscovered Union friends, who are now desperately needed to fill up the party's empty coffers now that the income stream from private donors is drying up.
The high bonus earners in the City are wealth creators - making vast sums of money for pension and investment funds amongst others. Hain, Johnson, Cruddas and their ilk just consume wealth, that of the taxpayer (including the bonus recipients), whilst indulging their political vanities.
I don't work in The City or earn those vast amounts of money, but I don't begrudge the efforts of those who do if it improves my financial position in retirement.
Large banks will simply move to more favourable tax regimes - what will Gordon do then to fill his black hole?
this article is interesting
Tim appears to have misread your comments about private equity firms and pensions since your expressed concern is 'whether the pension funds upon which many of us depend have been under-invested in the better private equity funds'. He is right to berate government interference as the ruination of private sector pensions.
Will Hutton was on Radio 4 yesterday being interviewed along with a less than totally convincing captain of private equity industry. He pointed out the extreme difficulty of differentiating between 'good' and 'bad' debt that renders the idea of removing tax relief practically unworkable. The suspicion of course is that private equity funds are merely a re-run of good old fashioned asset stripping. The truth of the matter is that private equity funds are only made possible by the carry trade; sourcing cheap borrowing internationally. This has tended to be Japan where the base rate is less than 1% (0% at one stage) but it is rising as their economy recovers. Japan is a great example of an economy where asset prices and P/E ratios ballooned, burst and decades of stagnation followed. Sooner or later one of the funds will do a Slater Walker and the enthusiasm will wane.
The trouble for you Paul Drummond, is that your outdated class-driven Marxist fantasy agenda is also not shared by the working class. Embarrasingly enough for a movement set up to represent the working classes, they repeatedly and ungratefully chose not to support it when given the opportunity at the ballot box. In fact, they preferred Maggie Thatcher.
The contenders for Brown's #2 job show their true Old Labour/Loony Left colours.
It's taken ten years in government, but we are now seeing what Labour are really made of: envious hypocrites who have never had a real job in their lives.
I will give Mr Hain 2/3 of my big fat city bonus, when he and his ilk stop paying thier mothers/other relatives, (who aledgedly 'work' for them) - out of the public purse. Don't do as I do do as I say, and if you don't like it we'll make you! Love Gordon. Gekko not Brown.
If the Labour government attempted to regulate private equity firms by ending tax deductibility, on their interest payments surely the companies would move
offshore and use complex structures that would in fact minimise their entire tax liability thus leading to less money for the treasury. Any attempts to regulate them via the tax system would be futile. It is interesting that for all of the noise coming from deputy leadership contenders about the moral compass of the City, the treasury themselves are sending an entirely different message, didn't Ed Balls say recently 'hedge funds are good for the economy'. You wonder if any of these ministers actually understand how valuable to the UK economy the City is, international financial services is an industry where are the UK is a world leader could you imagine the German government knocking their automobile sector. While the dangers of any real legislation effecting the competitiveness of the City is highly unlikely the constant carping from politicians seeking cheap points is damaging.
'aledgedly 'work' for them'
No-one said you had to have an educayshun to work in the City. Indeed, City employees are generally living proof of this.
Funny that Hain hasn't suggested football clubs pay two thirds of their players' salaries to charity, but has decided to go for the city instead.
However, the point about pension funds is quite interesting. Pension funds have lost out, not so much because of private equity, but because of the dash out of share and into bonds and other fixed (but low) return investments. This is a direct result of the regulations imposed on them by the current government.
But to the extent that pension funds have lost out to private equity, it is their own fault as pension funds are fond of bullying public companies and insisting on burdensome and unnecessary compliance with the myriad of Codes of Conduct (Higgs, Cadbury, etc), so no wonder they all jump at the chance to escape them by going private!
Leveraged buy-outs and restructuring of companies is a symptom of a failure of these (few) companies to make the restructuring themselves, over time. It is wrong to blaim the enterprising individuals who spot these opportunities for grabbing them.
Buy-outs perform a necessary function, as the threat of such take-overs keep CEOs on their toes, and make them work hard (only sometimes not hard enough) to keep the business as lean and profitable as possible. When done gradually, restructuring is alot less painful for everyone, and ends up with the same result (more profit), only the benefit goes to the existing shareholders (our pension funds).
Should pension funds invest more in private equity funds? This is equivalent to hiring another set of external managers to wring out the gains that the pension funds themselves couldn't get out when THEY owned the underperforming companies. Only these managers are hugely more expensive, and so is the process of flipping companies in and out of private ownership, and there is a great deal more pain all round.
Shouldn't the pension funds instead perhaps spend a bit more on good equity management, and actively exert influence over the companies they own, to avoid creating the opportunities in the first place?
PE deals are, by their very nature, economically beneficial. Firms plagued by bad management, inefficiency or lack of inovation are removed from the market and return as streamlined, efficient market leaders.
The fact that this may manifest itself in job-losses for individuals should not colour the economic benefit they provide as a whole. The basic economics of it is that resources, i.e. - people, are freed to be used elsewhere. What really undermines Hain etc and their criticism of PE as the creator of 'fat cat city types' is that they are infact a threat to the existence of them.
PE takeovers, or even just the threat of, work to diminish managerial entrenchment. Boards owning equity collectively less than 1% are not working to the benefit of shareholder or employee. They entrench their position to the benefit of only themselves. A PE takeover sees retained managers incentivised to work, alongside PE owners to the benefit of shareholder wealth; in the event they are extremely successful (benefiting shareholders, employees and the economy) they are handsomely rewarded and justly so for the benefit they bring to all.
Hain, Cruddas and Johnson's typical bolt from the blue statements regarding city bonuses and PE firms is one designed with little intention of PE reform. Why on earth would they? The importance of the City of London and its enlightened regulatory structure cannot be overstated to the economy as a whole. Rather, their comments are designed to appeal to the 'Man on the street', who picks up a paper, reads Hain's headline comments along the lines of "City Bonuses Bad - wealth to everyman good" and agrees with the sentiment and thinks 'good old labour, I'll vote for them'.
They are nothing more than hollow statements verging on morally irresponsible as politicians whip up a bit of a storm of bad sentiment and ride the wave to electoral victory. If it shows anything at all, it is that Labour will revert to type when the chips are down.
It is very interesting that now that Tony Blair is losing his grip, true labour rhetoric is coming to the fore. There seems little dought that there is some jockeying for position to become the next chancellor and showing that you have true socialist principles will help your cause with the next PM.
We live in a highly competitive global economy. Capital,offices and jobs can move countries very quickly. We could easily see London's pre-eminence disappear should Private Equity and other such financial organisations be singled out for tighter Tax treatment.
Mr Hain's idea was probably the most ridiculous I've heard all year. I don't understand why people seem to think they can single out one high-earning sector to give away their income whilst seemingly ignoring others. What about footballers, musicians and successful entrepreneurs? Will they be hit with Mr Hain's success tax. Individuals working in the financial sector are merely reaping the rewards of long hours and sacrifce. Their committment to their craft is not on a level playing field with the majority of Britons and nor should the rewards.
What I personally find worrysome is that three senior politicians are prepared to parade their economic ignorance as if it makes them more qualified for the job of Deputy Prime Minister.
The reason that the typical leveraged buy-out is financed 70% debt / 30% equity is that the valuation of the LBO company is based on its existing and future cashflows, which support a finite quantum of debt depending on the expected volatility of future earnings and profitability at the time of the purchase. Both banks and equity funds raise their liquidity in the open market, and buy that liquidity at a price according to the perceived risk in their investments - equity, ranking beneath debt in event of a default, has to pay more for liquidity, and must therefore seek a higher yield. To do so, it has to minimise the amount of equity required to purchase a company, and therefore hands over the existing profitability of the company to banks as senior debt, and increasing amounts of future growth in profitability to other financial institutions via 2nd lien debt, mezzanine debt, PIK notes and the like.
All of this means that - unlike Gordon Gekko (who was an asset stripper, a fundamentally different concept) - equity funds are now reliant on growing profitability in the companies they purchase, by both increasing the efficiency of the companies in question (reducing unnecessary cost, included jobs), and growing the revenues of the company beyond the plans of incumbent management. Which benefits the UK economy by increasing overall return on capital.
Hence why equity fund employees get paid ten times as much as idiot Labour MPs - they're doing far more for the economy.
I'm afraid you have committed the economist's fallacy; growth justifies growth.
Why must the candidates demonstrate that PEFs are good for the economy, regardless of the cost to jobs and conditions; when jobs themselves could, according to some views, be the main defining factor in what constitutes an economic good.
In other words, what you have written has an underlying ideology; onethat may, by some viewpoints, be correct, but will, according to people such as myself, be false.
Jobs are the primary economic good, and equality of income is the second.
Gus, I'm not sure if I understand your explanation for the leverage. There are, of course, many layers of debt, but the fundamental reason is that debt finance is cheaper to service than equity, the higher the portion of debt, the higher return (but also risk) on the equity.
As others have said, very cheap debt at the moment allows you to leverage the deals very high, this means PE firms can take public companies private using a relatively small amount of own capital, and therefore the gains made subsequently gives a very high return on this capital.
The question is, if this is the only re-engineering that the PE firm does, why didn't the management of the public company fix their balance sheet in this way themselves? One answer is "why indeed", but another answer is that it also concentrates ownership on a few private hands, this increases control over the company, and makes it easier to carry out the necessary changes to increase the value of the company, including in management.
So when the climate changes, and debt ceases to be so cheap, what will happen? The private companies will need to re-adjust their balance sheets, to do this they need to issue further equity, to do this they might well want to go public again. We're back where we started, the company is back into pension fund portfolios, minus the juicy gains that the PE firm managed to extract (and the pension funds failed to).
The problem (if that's the word) will probably fix itself, but in the mean time cheap debt is the facilitator allowing PE firms to swoop in and trim off some of the fat, if they have calculated correctly they can also exit and pocket the cash.
PS. El Tom, we could reverse your criticism, and say that your claim is that jobs are beneficial, regardless to the cost in capital (ie. your pension savings). Neither is true, they both create value in interaction with each other. Finding the optimal balance is the job of the markets, labour and capital. This is best done gradually, but when traditional capital (your pension fund) fails to keep the balance, the more predatory sort (PE funds) will do it for them.
The general assumption of those supporting PE firms is that they know how to run businesses to increase profits for the long term. However, all too often this is not the case and the firm taken over eventually collapses taking the pension fund with it. Fortunately for the economy, if not for the individuals who lost their pension, there are always real entrepreneurs who build real businesses that actually create wealth rather than merely moving it around.
Excessive leverage, whether that be by private equity investors or not, is eroding the tax take from the corporate sector which results in the rest of us having to pay more. Limiting, but not removing the deductibility of interest makes good sense. It would be perfectly reasonable for Corporation Tax rules to include a provision that interest and other financing costs are not deductible to the extent that they exceed one half of taxable profits before such expenses.
George,
An adjustment of your balance sheet to achieve higher gearing will push more of you cost of capital onto the debt side (where it is taxed as interest received) and less onto the equity side (where it is taxed as dividends received or capital gains). In the process, you will also pay less corporation tax, because the higher interest means your total profits are lower.
The overall effect is to reduce the proportion of your financing that is subject to double taxation (as equity is, taxed both as profit and dividents/CG). However, it is important to note that a change in the gearing is probably not motivated by this tax structure (it's not new), but by a change in the relative cost of debt and equity (debt has become cheaper).
While it is tempting to say that we should therefore also introduce double taxation on interest (which is what you do if you don't allow them to be deducted), this interferes with the decision-making that causes the adjustment in the first place. You think you're plugging a loop-hole, but in fact you're interfering with the workings of the market.
From a lenders point of view it's even worse, you're saying that, because interest is relatively low, we're not making as much tax as we would like, we will therefore tax lending much higher. I bet they'd love that!
If the tax take is a real problem, better to tinker with the overall levels than start changing the rules.
If we apply Peter Hainβs argument to another group of βundeserving high earnersβ i.e. Premiership footballers, the weakness of his logic becomes apparent.
If punitive tax rates were applied to top players, the ability of the Premiership to attract and retain the Worldβs best footballers would be fatally damaged as the best players would move to the countries that enabled them to take home the most money. The βinjusticeβ of a relatively small number of footballers earning vast amounts of money would have been fixed, but millions of football fans would be condemned to watching third rate football. Financial institutions and football clubs do not pay vast wages from choice, but because they have to if they are to be successful.
I am not bothered about how much money city dealers earn. I am very bothered about what I earn. I am also very bothered by the fact that old style class warriors like Peter Hain suggest that if I prove to be very successful in what I do, that they have some moral duty to take away money away from me that I have earned.
Focusing of money as the root of inequality misses the point completely. People become rich or not as a consequence of the personal, non-financial, capital that they are able to acquire in the course of their life. They become wealthy because they have skills that others value and are prepared to pay for.
London is a huge financial capital that given the size of our economy is great. I am from Birmigham and we lost our manufacturing sector to really bad management. As a sidenote i think we can be excellent specialist engineers - another form of intellectual property. Let the PE wave of change go forth.
But all benefit in business should be done on merit. A lot of very well paid city works dont deserve their bonus's. But in the next 20 years there will be no financial capitals but lots of competetive finance cities with good service and low rates.
But to end i feel for the workers who suffer most for poor management that will lead to the harsh winds of PE buyouts.
I always laugh at my older brother in the city as he often has the problem many of the above authors seem to have - complex microscopic analysis of a more simple macroeconomic issue, which some have touched on.
PEF's can only vulture on the meat if there is any meat to be had. Many of the British Institutions have fallen prey to them having spent too many years fatting up on complacency.
I don't think PEF's are in any way good in isolation, and cringe at the likes of Sainsburys' predicament, but overall perform a necessary evil to ensure the lean running of our greatest assets and therefore our economy as a whole.
The fact that 3 cronies have sparked up on the same idea is the sure-fire giveaway that it's entirely politically (and hence self) motivated! Roll on with the slow-motion Labour car crash!