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Last Updated: Monday, 2 July 2007, 14:29 GMT 15:29 UK
Quick guide: Private equity industry
The private equity industry says it is a vital UK investor
The private equity industry has increasingly been in the headlines over the past year - but how do these firms operate?

What is private equity?

Private equity firms are essentially investment companies.

The name private equity refers to how they raise the funds they use.

Instead of going to the stock market and selling shares, private equity companies raise funds from private sources, usually pension funds and wealthy individuals.

They then use this cash, along with borrowed money, to buy companies that they have identified as underperforming, but with the potential to do far better.

Their aim is to turn the business around and sell it on at a profit at a future date.

It is estimated that the private equity industry has invested more than 80bn in about 29,500 UK firms since 1983.

So are private equity buy-outs a good or bad thing?

Supporters of private equity, including the government, praise its ability to create jobs quickly and contribute to the economy.

Private equity groups claim they are improving the performance of UK companies by giving them stronger management and market discipline.

Yet others would disagree, most notably employees at companies which have been bought by private equity groups only to see hundreds of job cuts being made, such as at the AA or Birds Eye.

The UK's main unions describe such action as "asset stripping", saying the private equity funds have to make drastic cuts because of the excess debt they take on to finance their deals.

However, the private equity firms say they simply have to cut jobs to make the companies they buy profitable.

The transparency of private equity firms is another concern, with critics saying a lack of accountability means that decisions are made behind closed doors.

Why is the taxation of private equity groups controversial?

One of the big objections to private equity is the tax breaks given to the industry.

The most controversial is the tax on the "carry".

Private equity executives pay taxes on their basic pay and bonuses, but a large part of their income comes from carried interest - the carry - which is the 20% slice of profits they can claim once they have paid back their investors.

This money is classed as a capital gain and, thanks to something called taper relief, it is only subject to a tax level of 10%.

Critics say it should be charged at a normal tax rate.

It is an emotive subject, with one private equity boss saying that some of the richest men in Britain were paying tax at a lower level than the cleaners who tidied their offices.

But others say that if the UK changes its tax regime, private equity investors will just move overseas.

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