Mutual understanding: Private equity and the UK government

The relationship between private equity and government is tumultuous across the world, with even erstwhile private equity-friendly countries turning. In Sweden, once the poster child of private equity, local professionals described the industry as hanging on tenterhooks, awaiting the results of a trial on carried interest taxation. Fortunately, Nordic Capital's recent court victory has calmed the waters, for now. In Germany the FDP, the most sympathetic party to private equity, failed to garner enough votes for re-election when the nation went to the polls this year - though, as a consolation prize, the coalition agreement recently recognised the importance of private equity to economic growth.

But in the UK, the once acerbic relationship has mellowed to more palatable reciprocity. "I don't think members of the British Private Equity and Venture Capital Association (BVCA) have a great deal to complain about in terms of UK government, especially when you look at some other places in continental Europe where the relationship is much more adversarial," says Tim Hames, director general of the BVCA.

Perhaps the hand of the state took its most dramatic flourish of recent years in France, where the local private equity industry narrowly avoided taxation changes that could have left it in ruins. Thankfully an open dialogue with government sidestepped calamity.

As many European governments toughen their stances on PE, the UK and Ireland still offer a warm welcome

"When we came to power, one of the government tax commitments was to align income tax rates, whether labour taxation or capital gain taxation," explains Fleur Pellerin, French minister delegate with responsibility for SMEs, innovation and the digital economy. "Right after the industry became very vocal, I organised a public consultation on entrepreneurship called the Assises de l'Entrepreneuriat," she says. The policy was subsequently reviewed to incentivise risk-taking. A bullet was dodged through dialogue.

"The UK government is trying to run a pro-entrepreneur agenda and has been quite relaxed with regards to the business model of private equity," says Hames. "It's also been supportive of venture capital. The dialogue now is much broader; it doesn't have the abrasiveness of the Treasury Select Committee hearings of 2007 which - mercifully now - seem a very long time ago."

First-hand experience
Perhaps the relevant career history of several members of parliament has helped foster mutual understanding: for example, the present financial secretary to the Treasury, Sajid Javid, is a former employee of Deutsche Bank, where he worked in the private equity division. Says Conservative MP George Freeman: "One of the interesting things about the 2010 intake is that many more of us are entrepreneurial, which has not traditionally been the case in parliament. A number of us have started and run businesses, and worked in venture capital as well. From the industry's point of view, there are now people in parliament who understand it."

And the dialogue with the industry looks set to be amplified: Freeman, a former venture capitalist who leads parliament on life sciences, venture capital and the innovation economy, is working with Luke Johnson's entrepreneurs' network to help set up meetings with ministers and policy makers to promote an entrepreneurial manifesto.

Coalition support
Indeed, on the venture side, the coalition has shouted its support of entrepreneurs from the rooftops of Tech City, winning over former Facebook VP Joanna Shields and putting her at the helm. The digital economy appears to be the apple of the governmental eye. One industry leader told your correspondent that prime minister David Cameron had cleared his lunch schedule to invite senior Twitter executives to Number 10 prior to a final decision on the location for its new headquarters. Alas, a wasted lunch.

Nevertheless, the UK private equity industry is alive and well. The country consistently accounts for around 30% of deal volume across Europe, according to unquote" data, almost double the share of nearest rival France, making it the second destination in the world for private equity behind the US. But despite its European leadership, with the likes of Ireland steaming ahead with policy to lure in investors, Luxembourg's unbeatable fund structuring regulations and France's bold attempts to welcome high-skilled immigrants, the government must not rest on its laurels.

Adapt to survive
"The government is understandably nervous that, as a result of the Alternative Investment Fund Manager Directive, firms have to nominate where they want to be located," says Hames. "Luxembourg and Ireland are being fairly aggressive on regulation and tax, respectively. Not offensively so, but they are really laying out the welcome mat." To stay competitive, the UK Treasury is consulting on how to improve the Limited Partnership Act of 1907. "They want to make the UK, but London in particular, more attractive. And that's a sign of a government that's basically pretty sympathetic to the industry."

But, despite moves to stay apace with Ireland and Luxembourg on tax and regulation issues, many industry professionals agree that the approach to immigration is really holding back UK innovation. "The government mixes immigration as a whole with people who are trying to scam the system for benefits," says Marcos Battisti, managing director for Western Europe and Israel at Intel Capital. "Yes, that should be clamped down on, but at the same time you cannot have restrictions on the people with a lot of capabilities coming in. You have to give them the red carpet, actually." Hames agrees: "I think we have a real problem with immigration policy in this country. We have an entrepreneurs' visa system, which is fine, but you need more of an array. You need software programmers, for example. But there are still too few visas and they're too slow to come in."

Immigration policy
So what is being proposed to satiate the skills shortage? According to Freeman: "The immigration policy is to tighten welfare eligibility, but to be subtle enough to also make sure we are open to entrepreneurs, wealth creators and people with key skills from around the world to come and work here. We are introducing quotas for immigration into the UK, but crucially what we are doing, and need to be doing, is identifying key skills that we really need. And entrepreneurs fall into that category. I'm pushing the Home Office to create a fast-track system for people who are starting companies and employing people here, and who are going to create wealth here."

The French government is going one step further than a fast-track, taking a stars-and-stripes approach to rolling out the red carpet. Says Pellerin: "Many countries have the same kind of initiatives right now, because we all know that there is global competition for talent. If you look at Silicon Valley, 50% of start-ups were created by immigrants, so obviously one of the ingredients needed for a successful ecosystem is the presence of foreign talent. The idea is to have a full package, so the visa will be processed with shorter delays and it will probably be a long-stay visa. But there will also be visas for the families. I would like to implement a whole package where we can help entrepreneurs find a new home, premises for their company and help with school registration - all the things that make things easier when you want to settle in a foreign country." A law is expected to pass next spring.

Privately funded innovation
But the relationship between government and private equity runs both ways. Amid tightening government purse strings and structural deficits, could the government not turn to privately funded innovation to build a partnership as well?

Says Freeman: "Britain is on the cusp of a huge crisis. A structural deficit, like a ticking time bomb at the heart of public finances, with a broken model of unreformed public services. Things like the NHS will bankrupt public finances if we don't re-engineer them, and that means re-engineer them to work with the private sector to bring in new sources of revenue to invest in and develop new technologies, which would drive efficiency in productivity and make our public services a crucible of innovation and public-private partnership."

As long as taxation policy, industry regulation and employment rules remain largely untouched, the buyout industry seems to be content with a more laissez-faire approach from the UK government: the aptly named community keeps itself to itself. It appears then that it is the venture capital community that would be the central beneficiary of key policy changes.

"The VC community has long had some sort of relationship with the state," says Hames. "That's been true since the MacMillan Report of 1931 onwards. VC inevitably has to have some sort of dialogue with government, especially at a time of fundraising crisis. There will always be a conversation. I think that's where most of the energy and effort has to go."

But, as elections loom in the UK next year, which direction will that conversation take? 

 

Luxembourgish fund structures

Luxembourg took the recent implementation of the Alternative Investment Fund Managers Directive (AIFMD) as an opportunity to make an unbeatable name for itself as a prime location for fund establishment, particularly for private equity. The existing limited partnership model was modernised, and a new model instated. "These changes allow for greater flexibility for fund structuring and a tax-neutral environment," explains James Goold, partner in the private equity team at Taylor Wessing. Key characteristics include a rapid set-up, no requirement for a corporate legal personality distinct from its partners and a lower number of required filings to be made to the Luxembourg public registry, boosting confidentiality.

Says Goold: "The UK government is currently focusing on making the tax regime simpler, creating a more nimble regulatory environment and marketing the fund management skills and opportunities available in the UK. And the Chancellor announced that the government will begin a further consultation with the view of making changes to the Limited Partnerships Act 1907 to make sure that UK limited partnerships remain attractive to the private funds industry."

In 2013, the UK Treasury published a report highlighting the areas that need to be addressed to keep the asset management and investment management industries competitive. Significant reforms will include the abolition of schedule 19 stamp duty reserve tax, which will be legislated for in the Finance Bill 2014 to take effect in the 2014/2015 tax year. Previously, the schedule 19 stamp duty reserve tax regime had been a barrier to foreign investors looking to establish new funds in the UK.

 

Irish taxation rates

The Irish government has taken an aggressive approach to attracting capital; so much so that Ireland consistently tops the table for foreign direct investment. "I think the Irish government's efforts to attract venture funding to Dublin are absolutely commendable. They've carried on doing it despite the collapse in government finances on the back of the banking crisis. The Irish remain quick-witted and quick-footed," says Hames.

Thanks to well-known policies including a 12.5% corporation tax rate, R&D tax credits and IP licensing regulation, the country is now home to the likes of Facebook, Google, LinkedIn and Twitter. "These policies have been cornerstones of the regime for a long time," explains Ronan MacNioclais, partner in tax and legal services at PwC in Ireland. "We're at the stage now that there is a huge group of IT and IT-related companies all co-located here, which makes a cluster effect, which leads to even more development and smaller guys getting into the space."

But this year, the government set its sights on fund managers themselves. "We also have a variety of incentives for fund managers to try and get them to use Ireland. Hence the changes to the Finance Bill 2013 for carried interest," says MacNioclais. Under the changes outlined in the Bill, the conditions required to qualify for relief have been reduced: the scope of the relief now lies beyond start-up companies alone, in recognition of the lifecycle of venture-backed companies; the relief will be calculated on a portfolio, rather than individual, basis; the holding period required to qualify for relief has fallen from six to three years; and the relief now includes individual venture capital fund managers, not only partnerships and companies.

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