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Private equity firms that take over companies and bring in new management teams (management buy-in – MBI) are likely to cut jobs and depress employees’ wages. However, where an existing management team helps take a company into private equity in a management buy-out (MBO), they tend to expand jobs. The impact on wages is still negative, but less so.



Those are points made in a report* on the UK experience by the Work Foundation, an independent research organisation and consultancy based in London.



MBOs have accounted for the majority of UK private equity deals. In 2005, there were 259 MBOs, in comparison with 49 MBIs, according to the British Venture Capital Association. In the same year, £3.7 billion was invested in MBOs in comparison with £744m in MBIs.



According to the UK PE industry’s figures, some 1.2 million people are currently employed by firms backed by private equity. Around a fifth of private sector workers work for PE backed companies.



Overseas investors accounted for as much as four-fifths of funds raised by UK equity firms in 2005. Around 56% of this was from North America and most of the remainder from Continental Europe. Pension funds were the largest investors in UK funds, with 31% of the amount raised. They were followed by funds of funds (16%) – investment trusts that invest in a range of other funds - and banks (14%).



The Work Foundation report observes that information about the labour market effects of private equity ownership is – like everything else about the industry – difficult to come by. Not one of the firms approached for the report would divulge information – even regarding companies that had been sold on.



However, analysis of independently gathered data, which tracks companies as they enter and exit from ownership by private equity funds, finds that:

· MBOs (which account for the majority of private equity deals) cut jobs in the first year, but expand them thereafter - by an average of 36% over six years. Yet workers are £83.70 a year worse off than other private sector workers because wages grow more slowly.

· Where an outside management team is introduced to an organisation in a management buy-in (MBI), employment falls on average by just under a fifth (18.25%) over a six-year period. And workers are on average £231 a year worse off than other private sector workers.

Those findings are based on a study of 1,350 private equity supported acquisitions in the UK between 1999 and 2004 by the independent Centre for Management Buy Out Research. CMBOR, founded in 1986 by Barclays Private Equity and Deloitte, previously reported that private equity deals tend to cut jobs in the first year after acquisition but generally result in higher employment. That conclusion was widely reported in the media.



But the Work Foundation found that closer analysis of the figures revealed that about 60% of companies had increased jobs over six years while 36% had reduced employment. Many of those cutting jobs had been the subject of MBIs.



Further findings of the report are that:



· PE-controlled companies, whether the takeover is through an MBO or an MBI, tend to introduce strict new performance management systems such as performance and merit pay, regular performance appraisal, and new human resource management systems.

· Among PE-controlled companies, hostility towards trade unions is more pronounced than among private sector managers as a whole. Some 40% of managers in the PE companies say they are hostile. Only one in ten managers has a positive attitude. Similar figures for the Netherlands show a more favourable attitude. Almost one in nine managers were neutral about trade unions, while only 6% were hostile. The Work Foundation suspects that in the UK, union de-recognition is at the very least one motive for opting for private equity ownership.

· At present, there is a yawning information and consultation gap: the future of workers can be profoundly affected by PE deals, yet information and consultation rights are at present negligible.





The report makes recommendations in the fields of:



Socially responsible employment:

The UK government should set up a working group to explore the potential for introducing additional protections for workers affected by PE takeovers. One possibility is an amendment to the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). At present, TUPE does not cover situations where undertakings are transferred through share purchases. Transfers covered by TUPE are subject to a requirement of prior disclosure of relevant information to employee representatives; prior consultation with employee representatives; and protection of the individual employees affected. Employee representatives of firms involved in buy-out deals should be informed about where the money comes from and who are the ultimate investors (owners). Furthermore, Acas, the conciliation service, should be tasked with, first, monitoring employee relations in PE-controlled companies in order to gather better data, and, second, with supporting and providing advice on employee relations issues to PE firms and PE-controlled companies. The private equity industry should organise a forum for broad discussions with trade unions.



Taxation:

PE-controlled companies have been able to gain advantages through tax-relief on the interest on debt repayments. Moreover, partners in private equity firms and the managers they appoint have been able to gain tax breaks by treating profits as capital gains rather than income. The possibility of stricter rules on the amount of debt interest that can be offset against tax should be examined. And the government should ensure that private equity partners and top managers are paying appropriate tax levels. Some studies suggest PE general partners pay tax of no more than 4-5% on multi million pound incomes.



Transparency and debt:

Most private equity firms do not have the reporting obligations of a publicly quoted company. In response to public pressure, the UK private equity industry has agreed to supply more information. But the government should reserve the right to legislate if sufficient detail is not disclosed. One area of concern is the debt being loaded on PE-controlled companies. In the UK this can involve a shift in the balance sheet as extreme as moving from a publicly-quoted company with 70% equity and 30% debt to a private structure of 30% equity and 70% debt.



A Standard & Poors report released in March 2007 suggests that PE funds have contributed to the downturn in credit quality of European companies. “The advent of private equity sponsors in the past three years introduces new risks for European ratings, particularly for non-financials,” says the S&P report. The share of speculative grade-rated companies in Europe rose to 17.2% in 2006, from 1.2% 15 years ago, and 5% in 1996.



The rapid growth of PE in recent years therefore exposes a greater proportion of the economy to risks and potential instability. Of special concern is the pensions industry, whose members would be among the major losers if the PE train ever came off the rails, warns the Work Foundation report.







*Phil Thornton: “Inside the dark box: shedding light on private equity”, the work foundation, London, March 2007, 39p.

http://www.theworkfoundation.com/aboutus/media/pressreleases/privateequity.aspx

See also “Warning for workers over private equity firms”, Financial Times, FT.com, 26 March ‘07