The private equity industry has traditionally shunned the limelight. All that changed — perhaps for good — in 2007. Some of the most daring buy-out bids in its history were launched, for iconic companies including Sainsbury’s and Boots.
Unions in the UK, meanwhile, began an effective, if somewhat crude, campaign against the industry, portraying it as full of avaricious asset-strippers. Private equity suddenly became an issue in the battle for the deputy leadership of the Labour party. And the media began to scrutinise the industry and its methods much more closely.
Private equity was unprepared for the onslaught. A disastrous showing by leading industry players before a Treasury select committee hearing did not help; a week later the chief executive of the industry’s trade body, the British Private Equity and Venture Capital Association (BVCA), resigned.
In his keynote speech at the Legal Week Private Equity Forum held in London last month, new BVCA chairman Jeremy Hand admitted that private equity has become ‘the whipping boy’ for big business, and that public suspicion was high.
He also acknowledged that the industry now has a much-increased social footprint and had been slow to recognise that. “People in private equity have focused on their businesses at the expense of educating the wider world about what we do,” he said. “If people do not understand and do not know, they become quite frightened and we have not been very good at explaining ourselves.”
Hand, managing partner of Lyceum Capital, told the delegates that the industry has now “woken up to the reality of the world we live in”.
The Walker report
At the height of the furore, the BVCA commissioned Sir David Walker, a City grandee and Morgan Stanley adviser, to tackle the issue of transparency and disclosure. It was Sir David’s report
and guidelines — published in November last year — that dominated discussions at this year’s forum, with in-house lawyers and private practice specialists analysing their significance and likely impact.
The Walker report targeted the top end of the buy-out market, recommending that ‘large UK companies’ (see box, above right, for definition) in a private equity firm’s portfolio should publish an annual report and accounts, with enhanced disclosure, within six months of their year-end. This information includes the identity of the fund or funds that own the company, the names of the funds’ senior managers, an annual business review similar to those quoted companies produce and a financial review of the risks it faces, including those relating to leverage. The companies are also required to update this information three months after their mid-year point, and to provide the BVCA with data for an economic impact study.
A private equity firm owning or advising funds that control such a company is also expected to publish an annual review which includes enhanced disclosure or regularly update its website, describing its own structure, investment approach and leadership, and confirming it has arrangements to deal with conflicts of interest. The Walker report also called on firms to provide data to the BVCA as well as ensure timely and effective communication with employees, particularly during periods of strategic change.
The path ahead
So will this self-regulatory structure, which operates on a ‘comply or explain’ basis, work? Will it be enough to fend off private equity’s many critics? Or is it simply a step on the road to statutory regulation?
The BVCA’s Hand told delegates that he believes the new structure is “vital”, and pointed out that it will be subject to monitoring and further refinement by a group led by Sir Mike Rake, chairman of KPMG.
Calling for “a grown-up discussion” about private equity’s impact on the economy, he claimed that private equity portfolio companies outperform public companies on almost every metric, be it sales, exports or investment; something he put down to the way it operates, its efficient use of capital, and the close alignment of the business owners’ interests with those of management.
Hand promised that the BVCA would provide “rigorous, evidence-based research” on private equity’s economic impact. This, he said, will help the industry show — as Sir David recommended — how private equity returns are created on an industry-wide basis, whether through financial structuring, market movements or operational improvements.
However, Stuart Mills, former London head of Kirkland & Ellis and chairman of the International Bar Association’s private equity committee, sounded a warning that any BVCA-sponsored research must be credible. “If your goal is transparency and understanding and credibility, it will be interesting to see the research that comes out of the BVCA and how it is disseminated and whether it reports negative as well as positive developments,” he said. “If you only report positive developments, you will find people saying: ‘this didn’t work and we are going to need regulation’.”
Some delegates, meanwhile, expressed fears that the Walker report could lead to ‘regulatory creep’, where all private equity houses — not just those at the top end — are pressured to comply, whether by a subsequent extension of the regime or because of a fear of adverse media coverage.
“Sir David Walker deliberately pitched this at quite a high level,” said Sue Woodman, partnership counsel at Alchemy Partners. “We need to be careful that it is not seen as a sort of gold-plated benchmark to aspire to. [Walker] does not want venture funds to have to do all this, or even the mid-market.”
Woodman added that she did not think it would be a good use of smaller funds’ resources if they were forced to spend significant sums of money on becoming Walker-compliant.
A third concern was that the Walker report could disadvantage the industry, with other organisations that share some of private equity’s characteristics — such as sovereign wealth funds, hedge funds and entrepreneurs such
as Sir Richard Branson — not required to go through the same hoops.
Hand said the BVCA would promote the guidelines to such entities, but he admitted “some of those may be easier than others” to persuade to sign up.
Simon Witney, a partner at SJ Berwin, said the new regime “unquestionably” creates an uneven playing field — and that this was something Sir David recognised. “If you want self-regulation rather than black letter law, there is no real choice about it,” Witney explained.
He argued that, if anything, the transparency required by the Walker report could provide a competitive advantage. Witney also pointed out that the ‘comply or explain’ nature of the regime meant that if a private equity house feels it will be disadvantaged by publishing certain information “and can explain that coherently”, it is perfectly legitimate not to comply with a particular Walker recommendation.
Most panellists and delegates viewed the Walker report as an opportunity for private equity to restore its reputation, so long as it is not mishandled. A key question, though, was what lawyers’ role is in all of this.
“Walker’s view was very much that this is not a document to give to lawyers, it is a document that the business people should read,” Witney said. “He said this is a spirit document, not a letter document. He regarded the Takeover Code as a very good model for that.”
The in-house role
Nevertheless, it was felt that in-house lawyers do have a part to play. This could involve advising on compliance with the report, having an input into a firm’s public relations strategy, and influencing its approach to the wider issue of corporate social responsibility (CSR).
Mark Kenderline-Davies, general counsel at CDC Group, called on in-house lawyers to consider undergoing media training. “We have a media relations department and they work very, very closely with me and my legal colleagues to ensure we try and get a consistent message across,” he said. “As in-house counsel, one of the things you are paid to do is to minimise risk across your businesses.”
Similarly, Claire Wilkinson, general counsel at Omega Fund Management, argued that in-house lawyers have a pivotal role to play in the management of private equity houses’ public image and in advising their boards on how best to handle that “because of the training that we have and also because of the deal experience we have, which tends to be on an overview basis”.
David Dench, director of group legal services at 3i, suggested that in-house lawyers are well placed to advise on CSR more generally, not just on issues of transparency.
“[At 3i] we have the corporate responsibility mantra both as part of our core values as a business and the way we operate — our behaviours, our whistle-blowing policies — but also as an investor around ethical investing, socially responsible investing and so on,” he said. “A lawyer can play a part on both sides and often in-house lawyers can champion CSR — that is probably the sweetest spot that lawyers should look at to help promote the broader picture of private equity.”
It is undoubtedly too early to say whether Walker has struck the right balance between imposing additional reporting burdens on the one hand and retaining the private equity industry’s freedom to operate compared to public companies on the other.
Should his regime fail to deliver, then the prospect of statutory regulation may become a reality. What form this would take is unclear, although 3i’s Dench said one possibility was that private equity houses could be forced to disclose information on underlying assets they hold, something 3i as a public company already does in its accounts for its main 50 assets.
SJ Berwin’s Witney also pointed out that in the run-up to the introduction of the Companies Act 2006, there had been debate about whether it is right to differentiate between private companies and public companies in terms of annual reporting and whether what really mattered was the size of the business. Businesses that met a certain threshold should have to comply with the more onerous requirements of section 417 of the Act irrespective of whether they were public or private, the argument ran.
Witney said the Government rejected the argument, but that it had promised it would revisit the issue in a couple of years’ time. He also warned that private equity’s positioning was not just something that is being closely watched in the UK. “There is a lot of political momentum in Brussels for European-wide legislation,” he added.
Alastair Breward, chief operating officer of Amadeus Capital Partners, suggested that the confluence of public and private company regulation is driven by factors outside private equity disclosure. “It is a European theme that stakeholders in a company have more of a right to information,” he claimed, “so even if private equity becomes ‘cuddly’, we will still see a move in that direction.”
For now, though, the Walker guidelines appear to have bought the industry some time, while events such as the credit crunch have diverted the attention of the media and politicians. The lack of cheap debt has also reduced the ability of private equity houses to launch headline-grabbing bids.
A slowdown could provide the industry with a chance to demonstrate the economic value it says it creates. However, delegates were warned not to be complacent. “We may have a lull at the moment because people’s minds are on other things, but most of us expect there to be some high-profile problems with portfolio companies, maybe even some bankruptcies, some job losses,” said Witney. “When those things happen, they will get reported, the trade unions will come back and the industry needs to be ready for those moments and prepared for the response it needs to give.”
The BVCA’s Hand predicted that 2008 would be a critical year for the industry. The future for private equity, he added, “should be very bright, but it is by no means in the bag”.
