16 May 2017 by Lorraine Young
Private equity and portfolio companies’ reports will have to reach higher standards
Following events at BHS, the corporate governance spotlight is being increasingly targeted on large private companies, with the suggestion in the Government’s Green Paper that they should be required to comply with corporate governance principles. The final outcome of the various reviews and recommendations for change will not be known for a while.
Meanwhile, the profile of ‘activist’ investors is increasing as they call for change in large quoted companies – a recent high-profile example being the upheaval at Unilever following the unwelcome approach by Kraft Heinz, controlled by 3G Capital and Warren Buffett.
Private equity (PE) firms often take companies private – that is, off the public market – and run them for a period of time, at the end of which the PE firm may exit via a trade sale, IPO or some other form of restructuring. There are already efforts being made to improve disclosure and reporting by such companies – known as portfolio companies – while they are privately held.
In 2007, the British Venture Capital Association (BVCA) asked Sir David Walker to review the adequacy of disclosure in private equity. Following this review, a set of voluntary guidelines was published in November 2007 called ‘Guidelines for Disclosure and Transparency in Private Equity’.
Following company law changes in 2013, which introduced new requirements for the strategic report, the guidelines were revised in 2014. Companies affected were also required to report on how they comply with the guidelines in their annual report. The guidelines set out which private equity firms and portfolio companies they cover. The key priority to improve transparency and disclosure still remains.
“Each year PERG publishes a report setting out its findings on reporting during the previous 12 months”
The independent Private Equity Reporting Group (PERG) was set up in 2008 to review how well the private equity industry followed the guidelines and to make periodic recommendations to the BVCA for changes to them if required. Each year PERG publishes a report setting out its findings on reporting during the previous 12 months. Following this, another report is issued, which highlights good practice in portfolio company reporting.
The ninth annual report on how well the industry followed the guidelines was published last December. It found that compliance by portfolio companies covered by the guidelines had reduced from 95% to 88%. In addition, only 57% of the portfolio companies reviewed achieved an overall ‘good’ or ‘excellent’ level for their quality of disclosure, compared to 95% which achieved this level in 2015.
This looks very disappointing, however the report concludes that the apparent drop in standards was mainly due to higher standards of reporting in the FTSE 350, which is used as a benchmark for determining compliance with the guidelines, and the fact that for several companies it was the first year they had to comply.
“Perhaps the ‘naming and shaming’ will hasten better disclosure and attention to the guidelines”
The total number of portfolio companies required to comply with the guidelines fell from 62 to 60 and there were 66 private equity firms managing or advising funds which own the portfolio companies within scope – including firms that conduct their operations in a ‘private equity-like’ manner. The report found that a substantially greater proportion of companies had not published their accounts within six months of their financial year-end. PERG will start to name companies publicly that do not meet this requirement in next year’s report.
On the face of it, this is not particularly encouraging at a time when more attention is being given to governance in such entities. Perhaps the ‘naming and shaming’ will hasten better disclosure and attention to the guidelines.
Portfolio companies which are within the scope of the guidelines, but which do not comply with the requirements, are already named in the PERG annual report – in 2016 these were HC-One, Village Urban Resorts and Viridian.
However, in many instances, where gaps in disclosure were identified in companies’ annual reports, engagement by PERG resulted in the companies providing additional disclosure on their websites, with the intention to include the information in the following year’s annual report – so there are positive signs.
Areas where disclosure was identified as poor included human rights and gender diversity. Other areas of mixed performance were forward-looking requirements for trends and factors, due to a general lack of discussion of the business in a wider market context, as well as a lack of clarity about which board directors are appointed to represent the private equity firm.
In March, PERG then issued its latest report on improving transparency and disclosure in which good practice examples of reporting are highlighted. PERG commissions PwC to produce the report on good practice, designed to help portfolio companies improve the quality of their reporting.
In his introduction to the report PERG Chairman Nick Land states: ‘In light of the recent decline of trust in business and the resulting review by the Government into corporate governance, the guidelines continue to play a vital role in promoting the UK private equity industry as transparent and stewards of good governance.
Consequently the group would encourage companies to improve disclosures on how directors have performed their duty under section 172 of the Companies Act 2006, including consideration of the interests of stakeholders.’
The report identifies four areas where additional focus will result in an improved level of reporting. These are:
The report goes on to set out some guiding principles for annual reports. These are not new and state that annual reports should:
The guidelines themselves fall into three broad areas. The first is matters which are specific to the guidelines which focus on private equity-owned entities, such as the identity of the private equity firm(s) which own or control them, and which directors are appointed to represent the PE firm.
The second is matters required to be included in the strategic report for large private companies, such as KPIs and the principal risks and uncertainties facing the business.
The third is matters required to be included in the strategic report for quoted companies, which are included in the guidelines to provide comparability to the disclosures by listed businesses.
“Reporting of greenhouse gas emissions is only required for quoted companies, but is encouraged where available and significant for the portfolio company’s business”
These include the strategy and business model, environmental matters, employees and gender diversity, as well as social, community and human rights issues.
There is also brief mention of greenhouse gas emissions, reporting of which is only required for quoted companies, but is encouraged by the guidelines where the information is available and is significant for the portfolio company’s business.
The three areas noted encompass a total of 15 sections. The report explores the sections, setting out the requirement, advises on basic compliance and good practice, and gives examples of good practice.
There is a further requirements for a statement of compliance with the guidelines to be included in the annual report. If the annual report does not fully comply, this should be stated. If any of the guidelines are not relevant to a company, it is encouraged to explain why.
The reports can all be found on the PERG website (privateequityreportinggroup.co.uk), which also features useful Q&As, explaining which companies they apply to and when they cease to apply.