Lord Sikka is Emeritus Professor of Accounting at the University of Essex and a Labour peer in the House of Lords
Private equity is bagging a lot of businesses. Asda, Aggreko and motoring group AA are recent examples – and those are just the ones beginning with an A.
In some cases, these deals provide investment and create or protect jobs. However, many businesses that have had a period in private equity ownership have crashed, owing hundreds of millions to their creditors.
Hopefully, the businesses I’ve named will be well run and avoid the worst of the private-equity model discussed in this piece.
Concerns: Lord Sikka is Emeritus Professor of Accounting at the University of Essex and a Labour peer in the House of Lords
Private equity secures funds from banks, pension funds, insurance companies and wealthy individuals.
It then invests in asset-rich companies often through complex corporate structures, with secretive partnerships at the apex. Money is often routed through offshore havens to secure tax advantages.
The dash for high short-term returns is frequently accompanied by low investment, low wages and low staff morale.
Typically, private equity acquires control of a company and loads it with secured debt. The debt often comes from related parties – that is, from another entity under the control of the private equity owners.
They then are high up the queue to be repaid if things go wrong, and in the meantime can charge high rates of interest.
These lenders may be located in tax havens which levy little or no tax on profits and income from outside those jurisdictions.
The debt loading has consequences. Firstly, the interest qualifies for relief which lowers the tax liability and increases the return to shareholders. Secondly, if it has become a secured creditor, private equity drastically cuts the risks of losing money if a firm they have bought goes bust.
Normally, shareholders are the last to be paid from the assets of a bankrupt business and receive little or nothing. But with secured creditor status, private equity is at the head of the queue and is paid first.
So in these cases the risks are almost entirely transferred to suppliers, employees, pension schemes, taxpayers and local councils, all of whom are behind private equity in the line.
The private equity business model took its toll at Bernard Matthews, a family-owned poultry business founded in the 1950s.
In 2013, a private equity fund acquired control for £25million and loaded it with secured debt from banks and parties. The loan from the private equity shareholders carried interest at the rate of 20 per cent per annum.
In 2016, private equity sold the business assets and made a profit of £13.9million or a return of 56 per cent in a period of three years.
The liquidation is yet to be finalised and unsecured creditors – those lower down the queue to be repaid in an insolvency – who are owed a total of £134million are unlikely to receive anything substantial.
The pension scheme, with an estimated hole of £40million, has been rescued by the Pension Protection Fund, leaving some 700 members with a reduced nest egg, even though they made the required contributions in full.
The House of Commons Work and Pensions Committee wrote to Boparan Private Office, the buyer of the company’ assets. It asked why it did not purchase the whole of Bernard Matthews, including liabilities due to the supply chain creditors and pension scheme.
Boparan replied that it had offered to do just that, but at a lower price. This offer was rejected by the private equity owners.
The Pensions Regulator investigated and found the private equity profit was a legitimate outcome on a high-risk investment, there was no evidence of unreasonable conduct and no grounds to order a payment into the retirement scheme.
The debt-laden business model of private equity is killing businesses and jobs. It must be checked. Private equity investments need to be judged on the basis of business risks and not financial engineering designed to secure tax subsidies.
In 2017, the Government reduced the tax relief on interest payments. This must now be completely abolished.
Dangers of pension dumping
Warning: Baroness Altmann is a former pensions minister and a Conservative peer
Baroness Altmann is a former pensions minister and a Conservative peer in the House of Lords
What do a bed maker and a turkey farmer have in common? No, it’s not a riddle. Silentnight and Bernard Matthews are just two of many cases where private equity deals were followed by workers losing part of their hard-earned pensions.
The following practices do not all apply to these companies, but far too many employees in recent years have taken a hit on their retirement savings when their firm was taken over by private equity then put into so-called pre-pack insolvency.
Pre-packs, sometimes known as phoenix deals, are meant to provide a way of allowing troubled companies to keep trading and save jobs. They work by allowing businesses to ditch their debts, including pension commitments.
The firm, shorn of its liabilities, can then be sold off quickly, often to its own existing directors or owners.
Critics say some directors abuse the system by using it to rid themselves of debt and to buy back their business at a knockdown price, leaving creditors and pensioners in the lurch.
Those affected had generous traditional final-salary company plans, based on pay at retirement. Schemes like these are shielded by the Pension Protection Fund (PPF) if a firm goes bust, but members can still lose a chunk of their retirement income. Bernard Matthews is one of the most controversial cases, as Lord Sikka explains.
There are safeguards in place to try to stop unscrupulous firms trying to game the system and dump their pension funds onto the PPF.
Despite this, many private equity takeovers have been followed by corporate insolvency and the jettisoning of the pension scheme under a pre-pack. I believe the Pensions Regulator has not had enough powers to protect against deals deliberately designed to offload pension liabilities.
Another troubling case is Silentnight. The Regulator believed the mattress maker was pushed into an unnecessary pre-pack which offloaded the underfunded retirement scheme and reduced workers’ pensions.
There are real concerns about secretive private equity firms possibly engineering insolvency to give themselves first call on company assets.
Pre-packs can be important tools for saving jobs in viable but under-resourced businesses. However, there are suspicions that such phoenix companies may have exploited the pension protection regime.
The Pensions Regulator has recently been given additional powers to hold owners, directors and advisers responsible, even imposing criminal sanctions if pension-dumping is suspected. However, this behaviour can be very difficult to prove.
Even more worryingly, the Government has reduced the security of pension schemes on insolvency because it wants to protect jobs and firms damaged by the public health emergency.
This is a valid concern, but there are clear dangers of a sharp rise in pre-pack insolvencies being used, under cover of Covid, to get rid of more unwanted pension liabilities.
In the wake of the pandemic, it is increasingly important to be alert to the dangers of pension dumping. I fear a big rise in the practice and I am calling on the Government to ensure fair play for pension scheme members.
Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.