Michael Moore’s Outlook on why we need to speak plain language on ‘carried interest’
A few weeks ago I managed no further than the coffee shops of Helsinki airport before catching an onward flight to Tokyo. Finland cannot really be added to the list of places I have visited. Yet.
Nevertheless, passing through the terminal reminded me of the ‘Helsinki Principle’. Alas, this is not about the city’s standing as a place where diplomatic agreements have been thrashed out over the years. If only.
Instead, it is a nod to the mayor of the city who argued that English should become its third official language (after Finnish and Swedish) so that it could attract more foreign investors in a competitive international market. Smart idea, even if it proved controversial.
The ‘principle’ became my shorthand for the idea that if you want to communicate with a key audience you need to speak their language. (Of course, I will not be offended if it is confused for something far more important.)
Which brings me to ‘carried interest’. It’s a term of art central to private capital’s existence, but which to the lay person is at best meaningless, and at worst conveys a sense of something exotic and other worldly.
This is not helpful when public debate is focused on how industry professionals are taxed. And when a change of approach in the UK could fundamentally alter the international competitiveness of the world’s largest private equity ecosystem outside the USA.
But this is not an argument for better branding. Instead, it is about the need to use plain language to describe how the industry model works and delivers success time and time again.
The big picture on ‘carried interest’ is pretty well understood: private equity has for decades delivered exceptional returns for a wide range of beneficiaries and created jobs across the economy. For these reasons, private equity firms are seen, both by institutional investors and policymakers, as ‘partners for growth’.
To achieve these impacts the investment managers are offered the right incentives, and associated tax arrangements, to deliver shared goals of outstanding returns, and economic growth, over an extended period. But how, policymakers ask?
There’s a lot to explain, but we can show it starts with an alignment of interests, as allocators of capital entrust their success to specialist investment managers through a binding partnership.
And as a result the investment team’s fate becomes inextricably, and deliberately, bound up with outstanding performance in the fund, with no entitlement to a share of the capital value created unless that has been delivered.
The timeframe is next - these are long-term partnerships, with everyone locked together for ten years (and often longer). So the investments really do need to grow in value and generate returns at levels not found elsewhere.
None of which will happen without entrepreneurial risk-taking – the flip side of which is that there are no guarantees of success. There are no passive short-cuts here. Private equity firms are active owners who shape the management teams, agree strategies, bring in external operating partners to make businesses more competitive, and are focused on value creation in the businesses throughout their stewardship.
Which brings us back to the alignment point. Only when all of this comes together is there any ‘shared equity’ for the investors and their private equity managers, thanks to the capital value of the assets and the returns from the funds hitting the high threshold demanded.
And the element of this ‘shared equity’ attributable to the managers as ‘carried interest’ is only awarded in those circumstances. That outcome is binary and focuses everyone’s minds. Meanwhile, for the wider economy, we have businesses that are more productive, more internationally competitive and powering growth across the country.
Notwithstanding my aspirations to adopt the ‘Helsinki Principle’, there’s no escaping that this is a complex process. But to keep policymakers on board we need to keep showing that the model provides incentives to private equity (specifically in terms of their share of returns and how they are taxed) to invest risk capital actively over many years and deliver results which out-perform the toughest of benchmarks. And how that connects to creating wider public value.
At a moment in time when the economy desperately needs growth, the UK’s competitive advantage in private equity is a real strength. Showing how we deliver growth, and how the international competitiveness of our tax system matters to that, will keep us focused – and aligned with policymakers as well as investors.
Michael Moore
Chief Executive, BVCA
This article was originally published on 9 May 2024 on the Private Equity News website here.
