MAGGIE PAGANO: Many reasons why it is that private equity firms are leading the charge in takeover activity – but tax breaks are by far the biggest catalyst
Over the last week, the Daily Mail has run a campaign exposing the astonishing number of British companies that have been scooped up by private equity firms.
Since the outbreak of coronavirus last March, 123 companies have been taken over by private equity firms and there are another 19 deals in the pipeline. This takes the total value of takeovers to £52.6billion.
The Mail’s investigation also found that 26 of the 67 retailers which cut nearly 40,000 jobs over that period are either owned by private equity, or have been.
Planning ahead: Chancellor Rishi Sunak must address the problem of private equity takeovers
There are many reasons why it is that private equity firms are leading the charge in this takeover activity. But tax breaks are by far the biggest catalyst.
First, private equity firms structure their deals with huge chunks of debt because interest rates are so low. This means that interest payments can be set against tax.
Second, the individuals who invest personally in the firm are able to benefit from tax concessions – known as their ‘carry’ – which is the personal gain from their investment. This carry is taxed as capital gains rather than income and leads to some very big gains: a report in 2017 estimated that £2.3billion of carry was paid to 2,000 investors. It’s not just the tax benefits for individuals which are disproportionate.
Most private equity firms also tend to be bad at distributing wealth around the companies they buy.
Rather than spread their proceeds, by investing in new plant, R&D or labour, many of the owners pay themselves chunky dividends, often out of borrowed money.
So this too has a knock-on effect on the wider economy.
If Chancellor Rishi Sunak is serious about boosting growth, and promoting public markets via the so-called Big Bang 2.0, he should consider levying CGT on these individuals at their rate of income tax.
Owners should also be barred from paying dividends with borrowed cash, at least for a few years to discourage short-termism.
However, if Sunak wants to go further in fostering a new generation of equity capital and growing SMEs, he should consider excluding equity investment in some qualifying businesses, say those valued at less than £250m.
Such a measure would encourage those who are prepared to take risks with their capital – the origin of the capital gains tax – and discourage those who want to laden their companies with debt. It would certainly make the playing field more level towards equity rather than debt.
Yet despite the tax advantages of private equity, London’s public markets are thriving. Since the beginning of the year, there have been 35 IPOs on the LSE and AIM raising £8.7billion, and £16.3billion of equity was raised through IPOs and secondary issues with listings from Dr Martens to Moonpig.
In the first quarter alone, there were 25 floats, the most active since 2015, and in value terms, the highest seen since 2006. Fears that listings would be whisked off to Amsterdam or other European exchanges have not materialised.
Nor will they flee if the LSE has anything to do with ensuring London stays the most competitive and flexible financial centre for raising capital post-Brexit.
The exchange knows it cannot rest on its laurels, or indeed its legacy, if it is to stay ahead of European exchanges but also stop UK companies from going to the US to raise capital or being bought out by private equity. Which is why it is working so closely with the Treasury and the Financial Conduct Authority on finding ways to make London even more attractive.
These include the controversial proposals for Spacs – the blank cheque companies – designed to help investors raise funds via an IPO to buy private companies.
While the LSE backs Spacs, it has suggested to the FCA, which closed its consultation this week, that the market cap should be limited to £150m or less to ensure proper funding.
The meatier debate comes later this summer when the FCA opens up consultation on Lord Hill’s reforms aimed at modernising listing rules.
While they might sound radical – allowing dual class share structures to give founders more control over their companies and reducing free floats to 15 per cent from 25 per cent – they could help open up the public markets even more. Such moves are to be supported, so long as the rules are as transparent.
One size does not fit all. As one LSE director told colleagues recently, London needs to get the grit out of the system while maintaining the highest standards of corporate governance.