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Last month Permira, Britain's biggest private equity firm, published its annual review. It was a glossy 78-page publication full of information on Permira's portfolio - which includes investments as diverse as high street retailer New Look, gaming company Gala Coral and over-50s financial services group Saga - and an opening statement from chairman Damon Buffini.

Indeed, it looked much like any other company's annual review, but its publication represented a dramatic change for the notoriously secretive industry, because Permira is the first private equity company in the country to lift the lid on its inner workings.

This move, which other private equity companies are poised to follow, comes after a public backlash against the industry that many participants firmly believe was fuelled by a lack of understanding of how this sector operates. Buchan Scott, a partner at private equity firm Duke Street Capital, has stated that much of the negative reaction was due to the industry's lack of disclosure and its failure to communicate.

Getting the hump

Two years ago, the GMB union paraded a camel outside Buffini's local church as a protest against job cuts in two Permira-owned businesses: roadside recovery firm the AA and frozen foods group Birds Eye. Leaflets citing the biblical maxim that it is easier for a camel to pass through the eye of a needle than for a rich man to enter the kingdom of heaven were distributed.

The demonstration highlighted the fact that more than 3,000 jobs had been shed from the AA's 10,000-strong workforce since Permira had taken control two years earlier, while 500 jobs had been lost at Birds Eye following the closure of a factory in Hull. It focused public attention on the asset-stripping nature of some private equity deals at a time when the industry employs more than one fifth of all workers in the private sector.

The following year, Buffini was presented with a stuffed camel at a meeting with the GMB's general secretary. The union claimed that without the demonstration, the meeting - at which the union raised the issue of salaries and job cuts - would not have taken place.

In the spotlight
Buffini may have been surprised by the level of public vitriol, given that private equity has operated in the same way for decades. But as deals have grown larger, and household names have become targets of buyouts, the public has inevitably grown more interested.

The GMB also fuelled debate about the tax status of the industry, writing to more than 100 MPs seeking support for a campaign calling for better transparency and a review of tax laws that it perceived as unfairly benefiting privately owned companies.

Until the current credit crunch, the UK had become Europe's private equity hothouse. While the overall value of buyouts by private equity groups in Europe totalled £130 bn last year, spread across 775 deals, 40 percent took place in the UK.

Household names such as supermarket giant J Sainsbury were targeted (unsuccessfully), while high street stalwart Alliance Boots was taken private in an £11 bn buyout that triggered a £6.5 mn windfall for former CEO Richard Baker, plus huge cash payments for other directors.

The payments were labelled 'obscene and unacceptable' by the GMB. The deal also marked the first FTSE 100 company ever to have been successfully taken private in a private equity deal, raising the possibility that other seemingly untouchable companies could follow.

But the industry's traditionally private nature was mistaken for something more sinister. 'One of the joys of private ownership is privacy,' explains Richard Carpenter, development director of consultants Radley Yeldar. 'Privately owned companies don't have to reveal financial information to the public on an annual basis. But while the buyout of Alliance Boots meant a switch in ownership, the company still employed thousands of staff with whom it had previously communicated publicly. As larger companies were taken private, something had to change.'

Every day, the City pages of newspapers were filled with details of potential private equity deals and articles highlighting the anomaly that meant private equity financiers paid a lower rate of tax than their cleaners. The government finally responded to the groundswell of negative public opinion by raising the base rate of capital gains tax from 10 percent to 18 percent, partly to force private equity companies to pay more.

Making changes

The industry - begrudgingly, some would say - responded to this new image challenge. Last year, Sir David Walker, former chairman of Morgan Stanley International and a former executive director of the Bank of England, was asked by the industry's lobby group, the British Private Equity and Venture Capital Association (BVCA), to come up with some new guidelines for reporting.

Shortly afterwards, the spotlight on the industry was intensified when the Treasur y Select Commit tee decided to conduct its own enquiry into private equity, summoning industry leaders to its sessions at the House of Commons for a series of heated showdowns in the full glare of the public eye. A further round of hearings is scheduled for later this year.

If the negative attention of the unions was not enough to persuade some private equity groups of the need to change their communications strategy, the shock of the Treasury Select Committee ordeal certainly had the desired effect.

In November, Lord Walker published guidelines requiring more transparent reporting by qualifying private equity groups and their portfolio companies. The BVCA responded by setting up a working committee to monitor the effectiveness of the guidelines as they are adopted.

Any portfolio company that has undergone a public-to-private buyout, has a market capitalisation of more than £300 mn, generates 50 percent of revenues in the UK and employs 1,000 full-time (or equivalent) people should adhere to the new code. Companies that have undergone private-to-private buyouts and are worth more than £500 mn also fall within the net.

Critics have expressed disappointment, not least because the voluntary code does not require companies to disclose directors' pay. Instead, portfolio companies will disclose total remuneration plus details of the highest-paid director, without naming him or her.

Other things to be disclosed for the first time include returns, aggregate figures on value creation in the portfolio, investor breakdown by country and type, and shareholder return. Social responsibility and environmental issues - responsibilities that private equity firms have rarely focused on in the past - will also be included.

A positive message

The BVCA is actively encouraging firms to be more open. Chief executive Simon Walker says this is in the interests of private equity because it is time to communicate the good that the sector does for the British economy.

'The private equity industry is more likely to prosper if its economic contribution is publicly recognised and its investments do not cause suspicion or alarm in the wider community,' Walker says. 'We take self-regulation seriously, and this is reflected in the strong commitment the leading firms are showing to this process.'

In a speech last February, Walker emphasised that it is imperative for private equity firms to get the message across that they are a force for good. 'To say they have 'skin in the game' is an understatement,' he said. 'It really matters, for example, to Guy Hands and Terra Firma's investors if they can fix EMI. If EMI fails, Terra Firma's reputation is shot and its hands-on owner-managers will have lost their shirts.'

It is widely expected, therefore, that all firms meeting Lord Walker's criteria will comply, and that most can see the benefits in doing so besides merely avoiding more compulsory regulation. To date, 25 private equity firms from the BVCA's membership of 400 have signed up, because their portfolios are likely to contain companies that meet the criteria. But just 16 private equity firms are expected to report the financial results of their portfolio companies.

'We have to be seen to be good corporate citizens,' says Ben Harding, head of communications at private equity group Apax Partners. 'We are taking over household names, and people have a right to know what we are doing with them. We do have a good story to tell, it's just that we've been pretty bad at telling it.'

Balancing act

Chris Davison, director of communications at Permira, says self-regulation is not only necessary, but inevitable. 'It is incredibly important not to feel victimised,' he asserts. 'Lots of industries have experienced this in the past; they get to a certain size and people want to know more about them. It is a well-worn path, and now it's private equity's turn.'

But Carpenter also points out that there is a balance to be achieved with transparency. 'There was a competitive reason for private equity firms not to disclose lots of information, and there are also various regulatory issues to be taken into account,' he explains. 'But there is certainly a willingness among larger groups to embrace the spirit of Walker.'

This rings true for Chris North, chairman of Fishburn Hedges Design, who has seen a flurry of new private equity clients wishing to compile annual reports for the first time. While the new level of reporting will not go far enough to satisfy all the critics, being more open will bring benefits for private equity groups. 'A motivated workforce and informed stakeholders who understand the firm make for a better business,' says North. 'If your staff and customers understand and believe in what you're doing, you have trust and loyalty.'

Despite wide acceptance of the new code, however, 'there is still scepticism among private equity directors about the necessity of all this,' North continues. 'But this attitude will change, especially if people see a change for the better in relations with staff, stakeholders and customers.'

'The Walker report does expect a great deal from portfolio companies,' adds Davison, 'especially if they haven't had the infrastructure in place to report before this. But these are reasonable requests and reflect wider levels of interest in larger companies.'

Free publicity?

There may also be a vested interest in portfolio companies reporting financial information. On average, a private equity firm owns a portfolio company for three to five years, after which time it starts to look for an escape route. 'An annual report tells the portfolio company's story,' says Carpenter. 'It says who the company is and what it is doing. It is advertising for that firm.'

It's important private equity groups do not feel that adhering to the new guidelines is all they should be doing, Davison adds. 'There has been a lot of focus on the notion of reporting, and how private equity firms will respond, but it's important to remember that reporting is a not a proxy for genuine engagement,' he says. 'Private equity firms still need to get out and meet different stakeholder groups, because these groups still have their own different issues that need to be heard.'

If the industry really cares about improving its image and avoiding more formal interference from regulators, its ability to grasp this point may well prove more important than its willingness to sign up to self-regulation.
 

The Walker report on private equity

Reporting by portfolio companies
A portfolio company should publish its annual report and accounts on its website within six months of the year-end, and should include:

• The identity of the private equity fund or funds that own the company, the senior managers or advisers who have oversight of the fund or funds, and details of the composition of the company's board
   
• A business review that substantially conforms to the provisions of section 417 of the Companies Act 2006 - including sub-section 5, which otherwise applies only to quoted companies - calling for an indication of main trends and factors likely to affect the future development, performance and position of the company's business and to include information on the company's employees, environmental matters and social and community issues
   
• A financial review to cover risk management objectives and policies in the light of the principal financial risks and uncertainties facing the company, including those relating to leverage.

In addition, portfolio companies should publish a summary mid-year update no later than three months after their mid-year, giving a brief account of major developments in their business.

Communication by a private equity firm
A private equity firm should publish, either in the form of an annual review or through regular updating of its website:

• A description of its own structure and investment approach, and of the UK companies in its portfolio
   
• An indication of the leadership of the firm in the UK and confirmation that arrangements are in place to deal with conflicts of interest
   
• A commitment to conform to the guidelines on a comply-or-explain basis
   
• A categorisation of its limited partners by geography and type.

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