Approximately 12,000 UK businesses are backed by private equity and venture capital, accounting for 6% of the country’s GDP, according to the British Private Equity and Venture Capital Association’s (BVCA) latest report on investment activity. More than two million people are employed by those businesses, with over half of them outside London and the Southeast. A huge, positive force for good, then, insiders argue. So why isn’t private equity always seen that way?

To start with, certain parts of the industry may have hindered the cause: injecting funds into businesses in a costly manner, such as through preference shares that attract a high yield; select GPs merely bringing portcos dumb money and management by board meetings; and clients of PE-backed companies facing price increases each time the business changes hands, a slight made worse when private equity trades with itself.

Private equity’s image as debt-fuelling asset strippers is only exacerbated by the current macroeconomic climate, whereby the media landscape is quick to point out the contrast between funds raising record amounts and the average person facing a cost-of-living crisis. As GPs fly to safe but emotive sectors such as healthcare, the industry’s negative perception is perpetuated by headlines like the Financial Times’ pithy: ‘When granny gets LBO'd’.

While the media's pot shots at the London Stock Exchange are typically met with a strong rebuttal from the organisation, it has had free rein to have a go at the faceless and silent private equity industry.  

This is partly because private equity firms prioritise returns for LPs, a number of which are sensitive pension funds or endowments that quiver at the thought of a GP’s noisy commentary getting back to them.

However, the asset class has grown rapidly from the cottage industry status it once occupied in the 1980s, which even surprised the industry itself when it was caught in the headlights by a Treasury Select Committee inquiry in 2007.

Now, having been fuelled by low interest rates during the past decade, private equity has a greater impact on society. And with that comes greater responsibility.

Under threat

With the macro environment suddenly different, PE faces a number of threats should businesses, policymakers and the public both inherit and perpetuate the prevailing narrative about the industry.

“PE does have to worry,” says Andy Gregory, chief executive officer at BGF, which provides growth capital for small and midsized businesses in the UK and Ireland. “The broader industry is certainly going through a period where reputational risk is of increasing importance. The scrutiny on businesses doing the right thing is ever more important, as is the scrutiny on LPs putting their money into the right homes and being accountable for people behaving appropriately. Firms that don’t think about this carefully and address it will struggle at some point, regardless of their financial returns.”

One family office operating as a de facto private equity firm predicts that regulations arising from any PE backlash will make the fund model less appealing for LPs, while simultaneously making it tougher for GPs to transact with or grow businesses. The family office’s CEO believes this will increasingly pave the way for a new type of PE investor that has more direct links to capital and can commit to longer holds.

“We definitely have seen the category of family offices and high-net-worth individuals increasing their activity and becoming more comfortable investing with significantly fewer protections and controls than even we, as a minority investor, would take,” Gregory says in response to the trend. 

“But it is unlikely to be a materially competitive threat going forward. There’s just a huge barrier to entry for them, which makes it difficult; you have to be really credible to win the hearts and minds of entrepreneurs, on the ground, building up relationships, creating case studies, and demonstrating how you can help and advise businesses.”

Carry me home

Perhaps, then, a more credible threat is the possibility of a new government going after carry following the next general election, which former Labour Prime Minister Gordon Brown previously sought to do.

“Labour have been pretty clear that they want to close what it sees as the loophole around carried interest, and they've been pretty consistent on that point,” explains Lizzie Wills, senior partner and head of private equity at political due diligence firm GK Strategy. 

“Carried interest is something that they've been pretty clear they see as being difficult for beneficiaries to justify, and also just a bit of an outlier in terms of incentives in the tax system. So, I wouldn't be surprised at all if carried interest is included in the first Finance Bill that Labour brings forward.”

With that said, Wills further points out that there is little money in the public sector at the moment, so the party would be carefully assessing every tax relief and aspect of the tax code to identify where it could get additional receipts. 

“Carry is an obvious one but there may be changes around other entrepreneur reliefs in there as well. So, investors need to be cognisant of the fact there might be lots of other little tweaks that they probably haven't considered yet,” she says.

Aidan Robson, partner at Endless, a complex situations PE investor, believes the most important matter for the UK is growth, irrespective of the political party in government.

“We need to get back to a winning mindset in the UK, and you get that through growth. Growth drives higher tax returns, more investment into education, the NHS and society in general,” says Robson. “You can't tax your way to growth, and we have to get increased productivity into businesses if we want to become more profitable as a nation.”

The partner notes that private equity firms and their people want to be in the UK, but should the country become a less attractive investment prospect as a result of adopting onerous tax positions, they won’t be, claiming that their mobility will see them follow the capital.

“We’re investing money on behalf of US and European investors; they don't have to put their money into the UK. So, we, as a nation, need to be careful about capital gains tax, corporation tax and income tax, because the flow of capital moves far faster than long-term decision making in these areas, as shown by the Liz Truss mini Budget,” he adds.

Naturally, the chief executive of the BVCA, Michael Moore, looks to engage with the taxation issue from a positive angle: “Rather than turning in on ourselves, we should start from the other side and ask: ‘Which industry has got the capital resources, long-term take on investment, very active ownership model which can invest in all parts of the country across all sectors, while actually delivering the growth that has been on a painfully anaemic trajectory at a macro level in the UK?’”

Moore continues: “You want to make sure all the bits of the economy that can produce outstanding growth are firing on all cylinders, and that the tax and regulatory environment is competitive with everywhere else. 

"You want capital allocated to UK-based managers who will then invest a lot of that here in the UK. So, make the regime competitive – you will not just keep the people who live here, you'll get the next generation as well.”

Good news

So, what next to help private equity’s reputation? Industry players are split on the way forward, with a variety of ideas thrown around. As those within PE tend to be ‘numbers people’, some suggest that PE’s touchstone should be its positive impact on productivity, which is one of the UK labour force’s biggest problems. Others argue that the industry should move away from metrics, and capture hearts through messaging that is more human – stories explaining how private equity has had a positive impact on lives, thereby providing it with a face. One governance, risk and compliance adviser sums it up: “It’s great to have a conversation sitting at a high growth conference, but go talk about it on BBC Breakfast.” 

Further to these ideas, market participants point out that more transparency, employee ownership schemes and professional diversity wouldn’t go amiss.

One thought that gained traction among those canvassed was that PE should engage more with local authorities and communities across the country in order to win public support, thereby breaking away from its ‘London bubble’ association.

“The regional model is hugely important,” says BGF’s Gregory. “We’ve got 15 offices across the UK and Ireland, so the vast majority, over 70%, of what we do is outside of London and the Southeast. Many of our success stories have been in Northern Ireland, Aberdeen, Newcastle, areas that are traditionally far more conservative in their use of equity.”

The CEO, whose firm avoids leverage and invests from the balance sheet, goes on to say that the GP’s whole culture is about supporting entrepreneurs: “Having the entrepreneurs who have received capital from us become advocates of ours, talking about how we've helped them while leaving them in control, is hugely important. We have events where we bring along entrepreneurs we have previously backed to meet prospective entrepreneurs that we are currently talking to. We're very open and transparent about giving access to CEOs of our investee businesses.”

Advocacy is a point corroborated by Endless’s Robson, who reminds us that a PE firm’s capital predominantly comes from LPs such as universities, pension funds and medical foundations.

“If people understood that their university places, pensions and medical R&D are partly reliant on returns on capital invested into private equity, that would be fantastic,” says Endless's Robson. “For too long there has been negative press around private equity, probably because ‘private’ in the name implies that we are not open about how our sources of capital interact with the general public. But private equity and our LPs want this to change, and we need to promote more openly not only what private equity does, but where the returns go and how these help people in their everyday lives. Would we like it to change a bit quicker? Of course.”

BVCA head Moore points out the trade body is now more focused on the transparency and openness of private equity, highlighting The Private Equity Reporting Group website as a one-stop shop for a PE-backed company’s reporting. 

“That independent body tells you how it has marked the openness and transparency of those businesses. There's still progress to be made but the peer pressure and scrutiny that the media and others provide means that year after year, it is getting better,” he says.

By championing the positive contributions PE has made in supporting thousands of UK businesses to grow, ​​political adviser Wills notes that PE firms and PE-backed businesses have a “massive” opportunity to work with a more “pro-business” Labour Party, assuming we have a Labour government following the next general election.

The industry, in her view, can demonstrate that it is not the Wild West that many policymakers still perceive it to be, and instead show that it is, in the vast majority of cases, working in partnership with the public sector to help the government achieve its policy ambitions.

She concludes: “By and large, PE can show that it's come a long way, with a more rigorous focus on transparency, financial stewardship, better governance, ESG and benchmarking, both at fund level and portfolio level. 

"PE firms have put in a huge amount of effort to make sure that they can look themselves in the eye and say: ‘We're not the bad guys; actually, we're an important and constructive partner to policymakers, so you don't need to regulate us out of existence. We're doing a lot of good, particularly in a difficult economic period where politicians have relied on private capital to deliver services across the public sector.’”

Read the full Real Deals UK Midmarket Report here.