Private perils overstated

Sometimes parliamentary inquiries are not a complete waste of time.  There's an inquiry going on at the moment that might even prove to be useful.  The economics committee of the Senate is investigating private equity and its economic consequences.  Submissions from interested parties have been lodged and public hearings are scheduled in the next fortnight for Sydney and Melbourne.  The committee's report is due next month.

Private equity is hot.

The proposed takeovers of Qantas and Coles might have failed but this has probably only made private equity even more hungry to succeed on its next big deal.  A report this week from Ernst & Young speculated that even BHP Billiton could fall to a private equity bid.

So far most governments around the world have resisted doing to private equity what governments usually do when they're faced with something they don't understand -- regulate first and ask questions later.  Whether ministers can restrain themselves for much longer is debatable.  Already in Britain there are moves to change the tax rules applying to private equity partnerships.

Here in Australia we can only hope that senators take the time to read the submissions to the inquiry.

If they do they'll soon recognise that existing corporate and taxation legislation is more than adequate to deal with any challenges posed by private equity.

Rules covering, for example, foreign takeovers, insider trading, anticompetitive practices and thin capitalisation already exist.  The submission from the law firm Aliens Arthur Robinson puts it crisply:  "If it ain't broke ..."

The committee should take the opportunity to explode some of the myths about the operation of private equity.  These can be summarised as:  private equity is taking over the national economy;  private equity takeovers reduce government tax revenue;  and private equity takeovers automatically lead to job losses.

It might not be a bad thing if private equity was to take over the national economy, but that isn't going to happen soon.

Figures provided by the Australian Private Equity and Venture Capital Association (AVCAL) are stark.  In Australia in 2006 businesses purchased by private equity made up less than 1.4 per cent of the value of all businesses listed on the ASX.  Only 3 per cent of total loans in the Australian banking system are to companies backed by private equity.

So far there's no indication that the nation's banks are succumbing to a 1980s-like wave oflending mania.  The Reserve Bank identified in its Financial Stability Review in March that the level of interest now being paid by companies on their debt relative to their profit is half of what it was 20 years ago.

Next, there is the effect of private equity on government tax collections.  It's been assumed that high levels of tax deductible debt will lower tax revenue as company profits are reduced.  Even The Economist magazine believes this.  In its cover story of this week, The Economist argues that "because of tax breaks on interest payments (from which all companies, private or public, benefit), the growth of debt finance erodes the tax base".  But to consider only the impact on company tax receipts is to ignore the other half of the private equity equation.

AVCAL and others have pointed out that if the introduction of private equity increases the sale price of a business, then the capital gain to those who dispose of their interest in that business will increase, which in turn will increase the tax on that capital gain.  It is also often forgotten that the interest paid by companies on their borrowings is assessable income to the banks that lend out those funds.  Private equity transactions generate stamp duty, and of course fee income for fund managers.  As the Reserve Bank acknowledges, in the absence of more data we simply don't know what the outcome of private equity on tax receipts will be.  In all likelihood the impact will be negligible.

Finally, there are the employment consequences of private equity.  Contrary to common belief, the worldwide evidence is that on average firms backed by private equity hire more workers than firms financed from traditional sources.  Private equity investors are also more likely to innovate and invest in new technology.

Much of the commentary about private equity is overstated, and we most certainly are not about to witness the death of the public company.

The emergence of private equity should be welcomed.  The only people who have anything to fear from private equity are the executives of underperforming companies.

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