Australia: Corporate Law Update - Impact Of Private Equity In Australia

Private equity is not a new phenomenon, but over the last couple of years the level of private equity activity in Australia has increased significantly. This is not unique to Australia, as companies the world over are being bought by private equity funds and taken off stock exchanges, but there are now global private equity firms buying into Australian companies such as Alinta, Publishing and Broadcasting Ltd, Seven Network, Myer and Rebel Sport. This is a small but important part of the Australian economy.

In March 2007, the Australian Senate’s Standing Committee on Economics announced its inquiry into private equity, noting that private equity may often include investment by funds holding the superannuation savings of millions of Australians. The Senate’s committee is considering issues such as the lack of regulation and transparency in reporting, conflicts of interest, the exposure for Australia’s banking system and tax implications.

On 20 August 2007 the Senate’s committee released its report stating that private equity was not a threat to public markets. The Senate’s committee notes that private equity provides a source of capital for enterprises in addition to that available through the public capital markets. It has taken the view that the private equity market incorporates everything from funding new start-ups (venture capital), helping companies grow and develop, through to increasing the operating potential of developed companies. Publications

The report acknowledges that a key benefit of investing in private equity is the potential to earn higher returns than in the traditional asset classes. In addition to an injection of capital into buy-out targets, private equity was said to offer non-financial skills such as non-executive directors, extensive business networks and management expertise.

How Does Private Equity Work?

Private equity firms establish funds to invest in companies whose shares are not publicly traded, or to privatise public companies. Venture capital is a subset of private equity that is primarily targeted at businesses at an early stage of development.

Private equity and venture capital have many common features despite the different development stages of the businesses invested in. Both involve equity investment typically over a 3 to 5 year investment period in unquoted companies that are considered to have significant growth potential.

The acquisition usually involves the assumption of substantial debt by the fund or the acquired entity. The debt leverage may be in the form of bonds, preference shares or loans from a financial institution. Debt in such a leveraged buyout is usually significantly higher than equity, with risk accordingly being reflected in loan payments that have a higher rate of interest to offset the possibility that lenders may not recoup their capital.

Leveraged financing in Australia, the US and the UK (among others) over the past three decades has been hailed as a key to unlocking substantial returns for investors and for driving the improvement in the performance of individual enterprises and markets.

Private equity is perhaps best known for its management buyouts in which an entity’s senior executives gain the support of a financial services specialist to buy the enterprise and leverage the acquisition. The expectation is that the enterprise’s performance will be sufficiently improved to allow for the repayment of debt.

How Australia Rates Against The World

Australia’s funds management industry is the fourth largest in the world and highly regarded internationally. According to the Australian Private Equity & Venture Capital Association Limited (AVCAL), the local private equity industry raised more than $4 billion in capital in the 2006 fiscal year. Although the Australian private equity market represents about 1.4 per cent of the global market, it is increasingly attracting a greater share of the global transaction pipeline.

Private equity accounted for approximately 20 per cent of the total merger and acquisition activity in Australia in 2006, which was half the corresponding level of activity in the US and the UK.

Benefits of private equity to the Australian economy Private equity appeals to investors because it provides them with the potential for strong rates of return and lower overall levels of portfolio risk. It is popular because it typically has a low correlation with other asset classes like shares and bonds.

Businesses owned by private equity managers boost the economy by investing in additional employees at a significantly faster rate than comparable businesses. An Australian study in 2006 concluded that private equity backed businesses are an important employment creation vehicle with 76% expecting to hire additional workers in 2007. According to Dun & Bradstreet in their National Business Expectations Survey in November 2006, the corresponding economy wide measure indicated that only 5 per cent of non-private equity executives expect to hire more staff in 2007 than a year ago.

A PricewaterhouseCoopers submission, prepared for AVCAL, found that private equity backed companies are a major employer group, providing jobs for up to 700,000 Australians (8 per cent of the total private sector employment).

Private equity provides important assistance to small-to-medium enterprises (SMEs) by increasing the availability of capital to SMEs and providing SME owners who wish to retire from their businesses with a staged and attractive method of doing so by assisting with succession planning.

Australian private equity managers have played an important role in the industry’s development and are continuing to attract significant flows of investment capital into Australia.

Trends In Private Equity

Over the past two years, private equity activity has increased significantly in Australia. AVCAL suggests that this increase has been caused by three factors. Firstly, the high returns have prompted institutional investors, such as superannuation funds, to increase their allocation to the sector. Secondly, the global market for debt has grown and has resulted in private equity managers being able to grow more. Thirdly, the strong growth in the level of superannuation savings in Australia has made more money available for all categories of investment.

Private Equity Firms - Corporate Raiders?

Private equity is very public right now. Even though private equity has been shown in many cases to save jobs and build value, the industry’s own research has found that over a third of Australians are hostile about the concept of private equity.

The amount of publicity generated from the number of large-scale deals in Australia has meant that private equity has drawn its share of criticism and this backlash is not limited to Australia. The publicity generated suggests that some private equity managers give the impression of being little more than asset strippers after a quick dollar.

The controversial RJR Nabisco leveraged buyout deal in the US that went sour in the late 1980s and became the subject of the book "Barbarians at the Gate" was, at the time, widely considered to be the pre-eminent example of corporate and executive greed. This was the second largest leveraged buyout in history and is a landmark in American business history which has come to symbolise the 1980s buyout era that ended with a crash of a highly visible junk bond deal. The fall out from this deal still affects the reputation of private equity funds today.

The PricewaterhouseCoopers report sets out case studies of Australian companies that have received private equity or venture capital investment over the past five years. The report highlighted improved competitiveness and productivity from management advice. Private equity managers were reported to have a positive impact on companies’ cost management and overall strategy. The report also found that due to the close interaction between private equity shareholders and management, investor companies generally had strong corporate governance procedures in place.

It appears that the image of private equity as a tool for corporate raiders and asset strippers may not be justified and that in fact it contributes strongly to Australia’s economic growth by transforming companies, and attracting a high level of world class investment opportunities.

Swaab was recently named winner 'Best Law Firm in Australia (Revenue < $20m)' at the 2007 BRW-St George Client Choice Awards.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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