A quick glance through the national newspapers gives more
than a hint that the private equity and venture capital
industry is going through a big step change and facing exciting
challenges in the years ahead. To someone outside the industry,
this interest and coverage, and indeed the response it has
evoked, appears to have developed overnight.
A look at the events of the last 12 months helps to make the
picture a little clearer. First, there is the sheer growth of
the industry. The last two years have seen unprecedented
development in all aspects of the industry's activities
fundraising, investment and exits.
2005 was a record year for UK private equity firms. Funds
raised from investors reached £27.3 billion ($52.7
billion), compared to just £3.3 billion in 2004.
Investments reached £11.7 billion, up from £9.7
billion in 2004. The number of companies financed worldwide
once again exceeded the 1,500 mark at 1,535, of which over
1,300 companies were backed in the UK alone.
Over the last five years, UK private equity firms have
invested £33 billion. This investment has taken place
across all sectors of the economy, across all regions of the
UK. In 2005 there were about a dozen big deals done, while most
investment, over 80%, was of £2 million or below. These
are the thousands of smaller businesses that private equity
backs every year.
The UK is now firmly established as the centre of the
European industry, accounting for over 50% of the European
market. It is second in size only to the US. The BVCA (The
British Private Equity and Venture Capital Association)
represents over 95% of all UK-based private equity and venture
capital firms, speaking and negotiating on behalf of the
industry with media, regulators and government at home, across
Europe and around the world.
|Investment activity by BVCA
Source: BVCA Report on Investment
With this growth in the size of the industry has come
greater economic and social impact. It is well established and
broadly acknowledged that, from the specialist venture managers
through to the largest buyout houses, the industry invests,
builds businesses and creates employment across the
It is estimated that 1.2 million people, 8% of UK private
sector employees, are employed by companies that are backed by
A recent BVCA report, The Economic Impact of Private
Equity in the UK 2006, found that private equity-backed
companies create jobs at a considerably faster rate than other
private sector companies. Over the five years to 2005/6, the
number of people employed worldwide by UK private equity-backed
companies increased by an average of 9% a year. The rates for
FTSE 100 and FTSE Mid-250 companies were 1% a year and 2% a
year respectively. And nearly three-quarters of companies said
their growth was organic, rather than by acquisition, since
they had private equity backing.
These findings are also reinforced by a recent European-wide
study. The report examined the contribution by private equity
to employment growth in Europe. It concluded that not only did
private equity have a positive impact on employment, but also
"the value generated by PE is reflected in rapid sales growth,
healthy margins, larger investment budgets, accelerated
globalization" and that "PE-financed firms develop more rapidly
after the investment, clearly outperforming their competitors
and other traditionally financed firms" (Niewiem, Popp,
Rothenbucher and Scheiter, Private Equity Creates
Employment & Value, 2006). The study
attributes this out performance to the value creation
strategies adopted by PE-backed firms and investors.
The UK also demonstrates this positive contribution to the
economy by private equity-backed firms. Over the five years to
2005/6, on average private equity-backed companies' sales rose
by 9% a year, compared with FTSE 100 companies (7% a year) and
FTSE Mid-250 companies (5% a year). Exports grew by 6% a year,
compared with a national growth rate of just 2% and investment
rose by 18% a year, compared with 1% nationally.
In the BVCA survey of businesses that have received private
equity funding, over 90% of owners said that without private
equity the business would not have existed at all or would have
developed less rapidly.
Private equity is more than just the provision of capital.
Around two-thirds of businesses surveyed identified strategic
direction, financial advice and help with contacts as being
ways in which private equity houses had helped with the
development of their business.
The industry is a main factor in keeping the UK and wider
European economy flexible and dynamic. Private equity creates
strong and competitive companies that generate employment and
drive investment. The UK's global competitiveness depends on
its ability to be innovative and foster entrepreneurialism.
Private equity is an important driver of innovation and change
throughout the life cycle of a company.
|Non-financial contributions to
private equity-backed companies
Source: The Economic Impact of Private
Equity in the UK 2006
Impact as a financial service
The UK, and London in particular, is arguably the world's
pre-eminent financial centre, providing a global hub for
international institutions, firms and investors. The UK private
equity industry is playing an increasingly important role as a
profit centre within the financial services industry.
The UK private equity industry's role as a source of revenue
for firms operating within the broader financial and
professional services industry is increasing, contributing to
the overall impetus that these industries provide to the UK
Over 10,000 highly skilled professional staff work in or
support the UK private equity industry. There are around 5,500
individuals directly employed, over 3,500 of which are
During 2005, financial and professional services firms
generated an estimated £3.3 billion in revenue through
the provision of services to the private equity community,
representing around 7% of the total turnover of the UK
financial services industry.
UK private equity fund managers have long attracted capital
investment from outside their own shores, with an annual
average of £8 billion of funding flowing into UK funds
from abroad over the past six years. This represents almost
£50 billion of foreign investment over the past six
years, representing over 70% of the total capital raised by the
UK industry in that time.
Furthermore, 67% of the total capital invested by UK private
equity and venture capital firms over the past six years was
committed to companies within the UK, demonstrating a positive
net inflow of capital into the UK economy.
PE as an asset class
A driver of the industry's growth and impact is its success
as an asset class. Private equity has continued to outperform
total UK pension funds assets and the FTSE 100 and FTSE
All-Share over the medium to long term, delivering demonstrable
long-term out performance.
The net returns of private equity funds measured to the end
of December 2005 were: 21.1% over three years; 11.9% over five
years; 16.4% over 10 years and since inception 14.4%. Private
equity funds outperformed total UK pension funds assets over
the same periods and also outperformed the FTSE 100 and the
FTSE All-Share indices over the three time spans (BVCA,
Venture Capital and Private Equity Performance Measurement
Survey 2005, PricewaterhouseCoopers).
The superior returns generated for investors, who are
predominately pension funds and other institutional investors,
have guaranteed the continuing acceptance of the asset class.
The recent FSA review of the industry (FSA Discussion Paper
06/6 Private Equity: a discussion of risk and regulatory
engagement) highlights that a "considerable proportion" of
funds come from overseas and that only 5% of the funds raised
by UK private equity firms come from UK pension funds.
The BVCA has long campaigned to see a greater allocation by
UK institutional investors to the asset class.
When taking a broader view of the success and establishment
of private equity as a mainstream asset class, the growth of
the industry, and its economic and financial importance to the
UK economy as a whole, the reasons for the increased interest
in and scrutiny of the industry become clearer.
This success and the scale of the private equity industry
mean that it of course attracts the attention of the regulatory
The BVCA welcomed the FSA review of the industry that was
published towards the end of 2006. It is a timely and serious
contribution to assessing the role of the industry. Its
findings have implications not only for the UK but also for
regulators across Europe and around the world.
The review was generally positive about the industry, its
role and how it conducts itself. It stated:
"Private equity is an important component of a dynamic and
efficient capital market. Private equity offers a compelling
business model with significant potential to enhance the
efficiency of companies both in terms of their operation and
their financial structure. This has the potential to deliver
substantial rewards both for the companies' owners and for the
economy as a whole. This positive contribution to capital
markets is expected to increase over time as the private equity
market continues to grow and mature" (Private Equity: a
discussion of risk and regulatory engagement).
The FSA believes that the regulatory regime is effective,
proportionate and adequately well resourced.
Of course the FSA did highlight potential areas of concern,
particularly around the issue of leverage. The fact that the
review highlighted that some PE-backed businesses might
collapse was not a new statement. The industry is involved in
the provision of risk capital and inevitably there will be
losses. Debt levels are increasingly receiving more attention.
Appropriate leverage in a particular deal is a function of the
outlook for interest rates and the economy generally and the
robustness of the company's earnings. Misjudgements in the
investment process will be made in particular cases. Individual
failures are not symptomatic of a fundamental weakness in the
private equity model. Nor indeed are such occurrences unique to
the private equity industry, but rather a feature of the risk
of entrepreneurial business as a whole. What is important is
that these isolated failures not obscure the positive benefits
brought by the industry to the large numbers of businesses it
invests in and the excellent returns generated for the pension
funds that back private equity.
The BVCA will continue to work closely with the FSA to
ensure that the regulatory regime is appropriate and
The picture that all of this creates is of an industry that,
with its increasing size and reach, is affecting an
ever-widening base of interested parties. And this goes some
way to explaining the hype and headlines.
As fund sizes increase, naturally so do the sizes of
businesses that private equity can back. Equally it is
important to distinguish between deals actually done and market
speculation about possible opportunities. But there is a wider
stakeholder base with legitimate interest in what the industry
does and how it does it.
The BVCA has established an independent high-level working
group under the chairmanship of Sir David Walker to review
issues of disclosure and transparency with a view to producing
a voluntary code in the Autumn.
Despite the weight of research that highlights the important
economic contributions made by the private equity industry,
some negative perceptions exist. The UK has seen a number of
criticisms that seem strange for an industry that is about
creating jobs and value.
Value creation is at the heart of what private equity does.
Its success is driven not by leverage or financial engineering
but by creating long-term sustainable value.
The specific strategies adopted by private equity firms have
been shown to systematically generate value. In its study of
employment creation by private equity-backed firms in Europe,
AT Kearney has attempted to identify exactly how value and
employment is enhanced by private equity (Private Equity
Creates Employment & Value, 2006). Its
conclusion is that success is achieved by focussing on
strategies, that improve the performance of the business by:
examining internal operations; re-engineering and focusing the
existing business by reducing complexity and concentrating on
core businesses; and by examining how synergies can be created
perhaps by acquisition or strategic alliances.
Obviously these strategies are not just available to private
equity, but what has been evidenced is that the unique
combination of factors that private equity brings: a spirit of
entrepreneurialism and the alignment of management interests
and funding, allows the adoption of these strategies extremely
The last 12 months have seen the private equity industry
undergo some fundamental changes. Its move in to the public
arena through its success and growth has meant that the
industry has had to explain itself to an ever-widening base of
stakeholders. This attention is welcome. It gives the industry
a chance to champion the benefits private equity brings to the
economy and the UK's success in building world-class
Peter Linthwaite is chief executive of the BVCA - The
British Private Equity and Venture Capital Association
BVCA The British Private Equity and Venture
Peter Linthwaite was appointed chief executive of
the BVCA The British Private Equity and Venture
Capital Association in September 2005. He has been
involved in the private equity industry for over 17
Before his appointment as chief executive,
Linthwaite was a founding director of Royal London
Private Equity Limited, the UK mid-market private
Previously he has served as executive director of
Murray Johnstone Ltd, during which time he was managing
director, Murray Johnstone Asia Ltd, Singapore,
1995-2001 and director, Murray Johnstone Private Equity
Ltd, London, heading up the London operations,
Linthwaite had an early career in banking and
corporate finance after reading law at New College,
Oxford. He is married with two children.