The challenges facing private equity

The private equity industry is enjoying a renaissance in Europe, with an abundance of free-flowing debt, IPO exits and successful fundraisings hitting the headlines already this year. But some familiar problems persist, according to leading industry executives discussing the future of private equity at an event held by Dow Jones in London last night.

Buyout executives George Anson, the managing director of fund of funds HarbourVest Partners (above right); James Brocklebank, managing partner at buyout firm Advent International (left); and Warren Hibbert, founder of placement agent Asante (centre), shared their views on the buyout market’s past, present and future.

Taxation on fund profits, the growing influence of investors and the threat of a credit bubble were among the issues discussed by senior industry figures at the event.

Advent’s Brocklebank admitted he was “concerned” the private equity sector was “committing the sins of the past” by using leverage too aggressively in the last year, and acknowledged that debt financing packages for deals were reaching pre-crisis levels.

“2014 does feel like on the borderline of 2007,” he said. “I’m confident there won’t be a huge fallout, but certainly there is concern.”

The growing influence of investors, who are demanding more co-investment opportunities with buyout firms, lower fees and earlier access to deal pipelines was one of the topics of discussion among the panel.

HarbourVest’s Anson, who is also chairman of the European Private Equity & Venture Capital Association, said private equity firms and funds of funds needed to deal with a broader range of demands from a wider range of international investors who have the financial muscle to call the shots: “If sovereign wealth funds are looking for separate accounts then you have to respond,” he said.

But Anson said this did not mean that buyout firms were prepared to “go to the lowest common denominator to raise a fund”.

Some of the largest investors in private equity, such as sovereign wealth funds and large Canadian pension funds, have chosen to build direct investment capabilities in recent years in the hope of avoiding private equity management fees. The panel acknowledged the changes, but expressed reservations about how many investors were capable of executing deals and co-investments.

Hibbert said: “It starts with co-investments but very few can execute them. Sovereign wealth funds and large pension funds have developed internal resources, but have they got the best teams?”

Brocklebank voiced his doubts about how many could set up a “credible” direct business. “It is not that easy,” he said.

And while some institutions have competed with Advent on deals in recent years, he said it was no different to competing in a “straight fight” with other buyout firms.

Anson said the remuneration models at large institutional investors were set up differently to private equity firms, potentially creating problems for investors looking to go into direct deals.

Regulation, hardly one of private equity’s best-loved topics, was also under discussion.

Brocklebank said Europe’s Alternative Investment Fund Managers’ Directive had made a “big impact” on the industry after it was introduced last year. He said firms could benefit from complying with some of the rules, arguing that private equity is known as a “closed shop”, and that the regulation could help to force the industry to become more transparent.

Anson said AIFMD was “not perfect”, and could hurt investors’ ability to support funds which did not have the clearance to operate in certain European countries under AIFMD. He said: “There will be west coast GPs [general partners] which will not be able to set up an EU onshore programme. LPs [limited partners] don’t feel as though they have to be wrapped up cotton wool like that.”

The executives also spoke about the thorny issue of tax. Sweden’s private equity industry has been in a long-running dispute with tax authorities over whether carried interest – a firm’s share of profits from investments – should be subject to a higher tax rate. Earlier this week, the Swedish tax agency launched an appeal following an earlier ruling in favour of the buyout industry, and the issue is set to rear its head in other counties across the continent.

Brocklebank said he believed the industry “isn’t as transparent as it should be”, which did not help its cause with regulators. He said the question of tax was a “legislative issue”, which was likely to face further outside scrutiny in the future.

Asked how the buyout industry expected to face up to criticism of its tax practices, Anson said private equity could seize the opportunity to tell a positive story to legislators. “In 10 years PE managers will be more forthright about the jobs creation, growth and the tax they pay.”

“It would be a good story to tell,” he added.
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