Private Equity: Economic and Social Risks

Viscount Chandos Excerpts

Thursday 21st July 2022 Lords Chamber

[Viscount Chandos (Lab)]

My Lords, I congratulate my noble friend Lord Sikka on securing the time for this debate, although that timing, as the last business before the Summer Recess, has led to a group of speakers which, in the words of Private Eye, might be described as very small but perfectly formed, if that is not too self-congratulatory. The absence of any speaker form the Conservative Bank Benches would suggest either that the gameshow excitement of the past two weeks has been too much for them or they are already queuing to get into one of the 18 hustings between the two candidates to succeed this terminator of Prime Ministers. Either one of whom, I think even my noble friend Lord Sikka would agree, poses even greater economic and social risks than anything that could be caused by private equity.

My noble friend has spoken and written extensively over the years about his concerns about private equity’s impact on the economy and society, and in his speech today he has laid out these concerns very clearly. As will become clear from my remarks, I see private equity as a glass at least half full in its economic and social impact as opposed to my noble friend’s glass at least half empty. None the less, I am very grateful for the opportunity that he has given the House to consider this important subject.

I declare my interest as a trustee and investment committee member of the Esmée Fairbairn Foundation, which has substantial investments in private equity funds where I have no personal financial benefit; and as an investor through my personal pension fund in the private equity fund of funds, HarbourVest Global Private Equity, where I obviously have a personal benefit.

The experience of the Esmée Fairbairn Foundation, one of the largest grant-making foundations in the UK, represents a microcosm of some of the benefits from private equity investment. Over 15 years, these investments have become the most important contributor to the foundation’s investment performance and hence to its ability to increase its grant-making by many millions of pounds more per year than would otherwise have been the case. The same is true, I believe, for the Wellcome Trust, whose genuinely world-leading work in medical research and healthcare has grown hugely off the back of its private equity returns.

Analysis by the leading investment advisory firm in this field, Cambridge Associates, suggests that there is a strong correlation between the overall investment performance of major US endowments and foundations and the allocation of 15% or more of their investments to private equity. Globally, academic research; improving access, diversity and inclusion in higher education; disease eradication; poverty alleviation; and many other causes are benefiting by billions of dollars a year from the superior returns achieved by successful private equity investment programmes. The same is true to a more limited extent to members of those pension schemes able and willing to invest in private equity.

Of course, none of this would be acceptable if these were returns at the unacceptable expense of employees, consumers or the environment and that is clearly my noble friend’s concern. Private equity as a generic term covers, as my noble friend might see it, a multitude of sins or, in my more nerdishly neutral way, a multitude of sub-asset classes. According to alternative asset data provider Preqin, globally, there are around $3 trillion of assets invested in or committed to buyout funds, on which my noble friend has focused his analysis and remarks.

However, almost as much—around £2.8 trillion—is invested in venture and growth capital, through which start-up, early-stage and fast-growing companies are supported. In these cases, little or no debt is used, so there is not the leverage risk that might apply to buyouts, to which my noble friend referred. These fast-growing, innovative companies are important generators of jobs and, through their products and services, benefit both consumers and enterprises.

Although the adoption of formal environmental, social and governance—ESG—policies by private equity managers is growing fast, with over 40% now having done so, even those venture and growth capital managers that have not yet done so are, through their focus on innovation and the industries and markets of the future, delivering higher levels of impact than, say, a typical public markets equity fund.

That is not to say that there are no issues for this key segment of the private equity market. For instance, a life sciences venture capital fund may take a transformative new drug or therapy from the earliest preclinical stage all the way to licensing or selling it—a pinnacle of high-impact investing, in my view. This does not guarantee that it will be made available to healthcare systems around the world at an affordable price. I suggest, however, that this is a broader issue than that of the role of venture capital or private equity.

Even when looking at the activities of buyout firms, as my noble friend has done, my feeling is that in many cases the issues are more general to the overall corporate sector than specific to private equity. Employment rights, pension protection, thin capitalisation, insolvency law, competition and merger policy are all areas where significant improvements are needed in corporate law and regulation, to which private equity and private equity-backed companies must adhere.

In thinking about insolvency law, I was interested to read the ruling of an Appeal Court judge:

“I have long thought … that the ordinary trade creditors of a trading company ought to have a preferential claim on the assets in liquidation in respect of debts incurred within a certain limited time before the winding-up. But that is not the law at present … winding-up debenture-holders generally step in and sweep off everything; and a great scandal it is.”


Those were the words of Lord Macnaghten in the case of Salomon v Salomon in 1897 and, 125 years later, not much has changed regarding the rights of unsecured and trade creditors.

My noble friend raised a number of specific issues about private equity. While it is for the Minister to address them, I would like to express a view on a few of them. I do not believe that there is a real systemic risk arising from private equity. The degree of leverage of the investment banks in 2008 and the issue of subprime mortgages and mortgage-backed securities are of a different scale from anything that currently exists in leveraged buyouts. I look forward to talking to my noble friend outside the Chamber, but do not understand his analysis that private equity is leveraged 30 times. The average leverage applied to companies acquired by private equity firms is somewhere between six and eight times the EBITDA of those companies.

I was struck by the companies he listed in his example. Many of them seem to come from sectors, whether airlines or retail, that are clearly going through major challenges in the current changing consumer environment. I accept that there may be cases where private equity firms’ behaviour exacerbated those problems, but in other cases I believe there are retail businesses, for instance, that have been given more chances than might otherwise have been the case by the willingness of specialist private equity firms and restructuring funds to attempt to turn those businesses around.

Yes, sometimes private equity funds may make a relatively quick gain. That may be through asset stripping —which I think is very much less of a practice than it was 20 or 30 years ago—but in general one of the positive aspects of private equity is an ability for private equity funds to take a longer-term view than investment managers in the public markets can.

In conclusion, I believe that, as in every area of the social market economy, improvements could be made to regulation and practice in the private equity and particularly buyout markets, but overall they make a positive net impact to both the UK and global economies and contribute to employment and improving the lives of many members of society.