What is private equity?
Private equity firms buy up large stakes or gain control of businesses with the aim of disposing of them in a few years time at a handsome profit. They raise the capital to do so from investors – and the rewards can be massive.
When deals go wrong, private equity can still make fabulous sums if they sell out before things turn sour – even though their methods may have weakened the business.
How do they make their rich rewards?
The idea is to buy at a bargain price, improve performance and sell at a profit over a short time frame or float the company on the stock exchange. The fees that private equity firms charge investors are often hefty.
Private equity firms buy up large stakes or gain control of businesses with the aim of disposing of them in a few years time at a handsome profit. Picture: Stock
Who are the big players?
They are little known. The larger British operators include Permira, CVC Capital Partners and Bridgepoint. Some major US private equity outfits such as TPG Capital and Blackstone exert huge power over British jobs and businesses.
Why do we know so little about how they operate?
Most private equity firms are owned by their founders and partners, and can operate at a lower level of scrutiny than companies that are publicly listed on a stock market. The latter have to provide regular accounts and other information – private equity operates behind closed doors.
Where do the firms source their money to make deals?
From pension funds, insurance companies and the occasional wealthy individual. They invest in a portfolio of companies and try to squeeze profits out of them to make a chunky return for their investors, and themselves.
Do they use a large amount of debt?
Yes – and this is key. Often they finance takeovers with borrowings that they load onto the company itself, so it ends up owing large amounts. There are tax advantages to using debt and it ramps up the returns to private equity, provided they can sell a company on at a profit.
The firms source their money to make deals from pension funds, insurance companies and the occasional wealthy individual. Picture: Stock
But if things go wrong, high levels of debt magnify the damage. Companies bought in debt-laden private equity deals may be more likely to push down wages and cut investment, as well as having a higher risk of going bankrupt. Sometimes, private equity owners will pay themselves large dividends out of borrowed money.
Don’t private equity firms suffer if a deal goes bad?
Not always. Because of the way deals are structured, private equity owners can escape with large profits from companies that later turn into disasters.
Examples include care home group Southern Cross and collapsed department store chain Debenhams.
Do the firms qualify for tax breaks?
Yes. Some interest payments on debt are deductible against tax. And wealthy private equity barons benefit from big tax concessions, including on their ‘carry’, the personal payouts on deals. These can be taxed as capital gains rather than income, resulting in a lower rate.
Some private equity barons pay lower tax rates on chunks of their multi-million pound hauls than employees on £50,000 a year.
A report by the University of Warwick and London Business School last year found that in 2017, £2.3billion of ‘carry’ was paid to 2,000 individuals.
Because of the way deals are structured, private equity owners can escape with large profits from companies that later turn into disasters – examples include collapsed department store chain Debenhams
If all carried interest was taxed as income it would have raised an extra £440million for public spending.
How much do private equity barons earn?
Senior figures are multimillionaires if not billionaires, but information is usually under wraps, unlike with public companies.
A few very large private equity firms are quoted on the US stock market – Stephen Schwarzman, boss of Blackstone, was handed £430million in dividends and pay last year.
Is anyone scrutinising the sector?
Not enough. Huge deals including the takeover of security group G4S for nearly £4billion by a smaller US private equity-backed rival were simply nodded through, even though the company employs 25,000 people in the UK, and has important contracts including running prisons and Covid test centres. It also guards Hinkley Point C nuclear power station in Somerset.