Legal Village

Lessons from a private equity nightmare

Posted 23/01/2008 by Charles Martin

Last year might well go down as an annus horribilis for the private equity industry.

A lucky few made some spectacular exits during the first half of the year (from investee companies, by IPO’ing or selling stakes in the managers themselves). Most in the industry, however, will remember it for the credit crunch and the sustained and hard-hitting attack on private equity globally by the unions, the press and, in the UK, by Parliament.

Initially this onslaught was not handled at all well and major PR blunders made a tricky situation worse. The industry seemed to be unable to articulate what it does and why that is a good thing for the economy and society generally.

Things have moved on. Household name targets are no longer daily associated with private equity bids. The short-term outlook for the industry looks less rosy. Tax changes are coming (albeit that they might well miss the target). The industry-sponsored Walker Report has recommended a voluntary code of increased transparency, which has received widespread endorsement (although many of the all-important details are still unclear). There have been senior management changes at the British Venture Capital Association, which has in turn been given a quasi-regulatory role to set up a committee that will name and shame non-compliers with the Walker Code.

Nonetheless, it has been a nasty time for the industry. So what are the chances of the legal profession being next up for the same sort of treatment?

Of course, there are a number of important and obvious features that we don’t have in common. We don’t inject leverage into businesses and give rise to the kind of financial instability that caused the FSA to express concern in its report. We don’t make large numbers of people redundant or acquire control over household-name businesses.

There are some more subtle differences too. For example, we pay a lot more tax than most cleaners (according to Nick Ferguson of SVG, unlike many senior figures in private equity, many of whom he accuses of paying next-to-no tax at all). That is because those of us who practise here have little scope for sheltering any of our income offshore (nothing wrong with that) and are taxed on it as income not capital (that’s because it is income, but then so many would argue is private equity-carried interest).

Ironic, then, that the Legal Services Act 2007 (which was designed to open up the profession) may have the effect of creating substantial capital gains for some lawyers if they sell equity in their firms. Even if they end up paying 18% tax on those gains (because business asset taper relief of 10% or lower will not be available by the time the Act’s provisions become operable) that is still a lot less than 40% plus National Insurance, which is what they would pay on income.

But even without capital windfalls, like the private equity industry, the level of earnings in the legal profession are enough potentially to attract accusation of fat-cattery.

The claims of lack of transparency in private equity that led to the Walker Report were, many would say, largely about how much money people are making and, of course, the report does not really do much to address that. Like private equity managers, law firms are privately-owned, private businesses and, on the face of it, are entitled to their privacy. However, many have taken advantage of the ability to become limited liability partners, paying the price of public disclosure along the way. The result of this - and an amount of voluntary disclosure through the legal press - means the profession has little to hide. 

The only lack of transparency that we can be accused of is failing to explain adequately to the outside world what we do and how we do it. That is where private equity went wrong too. If we do not do something about it, it could make us vulnerable to attack. We would do well to prepare for it and to make sure that, as a profession, we have done everything we should to explain what we do and what the benefits are of it to the business world and the broader economy.