Private equity is really just a group of rich people getting together to buy up all the shares in a company. So why are people so bothered?

And even the most ardent private equity haters would concede that a private company is likely to operate far more efficiently than a public one.

After all, many public companies resemble government-owned enterprises, with senior management acting like a politburo, receiving gargantuan remuneration for lacklustre performance from sycophantic boards, while returns on investment are often sickly. Private companies are able to act more dynamically to changing conditions and closely link pay to performance.

No, that’s not the problem.

The biggest social concern over private equity buyouts is their significant use of debt in converting a company from being publicly listed to privately owned. Not only does that debt increase the risk of default and the cost of borrowing but, more importantly, it creates a “tax shield” which means that the equity holders are able to pay very little tax on operating earnings (as all earnings are used to pay of the significant interest bill).

Way back in 1988, during the height of the last LBO boom, Laura Sanders wrote a piece in Forbes headlined “How the government subsidises leveraged takeovers”. Sanders quoted Harvard tax law expert, Bernard Wolman, who claimed that it was “stunning … that so much has been written about takeovers and leveraged buyouts without paying attention to the fact that a large part of the price is provided by taxpayers.”

While the US taxation system is different to ours — the Yanks don’t have our system of dividend imputation — if Qantas is snaffled by private equity, the government could lose as much as $200 million a year in tax receipts that Qantas would have otherwise paid (but doesn’t due to the tax-deductibility of interest payments).

Over five years, the total may approach hundreds of millions, although some of the tax saved by Qantas’s owner would be offset by initial capital gains paid by current shareholders and additional tax paid by lenders. The rort has even been encouraged by the government with its capital gains loophole allowed for overseas investors.

It would be fair to argue that hundred of millions of dollars that would effectively be transferred to the relatively anonymous (and possibly foreign) investors would be better off used hiring more teachers and nurses. But that would be a lot less exciting.

Peter Fray

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