Private equity firms are suddenly navigating global uncertainty. Guiding portfolio companies through the pandemic-driven upheaval is a daunting challenge: helping them cope with shutdowns and delays, swerve clear of cashflow crunches and avoid defaults.
At the same time, you need to keep capital calls rolling in from their own investors, closely monitor deals already in the pipeline and ensure that their own businesses run smoothly.
And then there’s the need to plan for the future. The jury’s still out on whether the global economy is set for recession due to the COVID-19 pandemic. Could private equity funds armed with a record level of cash benefit from bargain investment opportunities down the road?
With so many factors to consider, we want to offer five tips that private equity funds should consider.
1. Keep cash flowing
“It has always been about cash flow,” said Michael Vaccarella, co-leader of Wipfli’s private equity services and leader of the transaction advisory services team. “Now more than ever, we all need to assess our current cash position and expected cash flow. We need to protect the house.”
As global shutdowns rattle the economy, funds need to ensure that portfolio companies are adequately assessing their cash positions and expected cash flow. Run through various scenarios to calculate how long your companies can last on the cash they have. Scrutinize their cash-flow analysis and forecast how much more they’re going to realistically need.
In uncertain times, it’s important to consider both traditional and alternative finance arrangements. Limit risk by combing through debt covenants to verify that companies are on track with their borrowing terms before taking on additional debt.
When it comes to investors in your fund, keep them up-to-date on all the steps you’re taking to get through the current disruption. If they’re slow to respond to capital calls, consider “bridge loans” to fill the short-term gap.
2. Get hands-on help
Now’s the time for funds to get hands-on and work closely with portfolio companies to ensure they survive and even thrive once the current storm passes over.
Consider a one-size-fits-all emergency response that can be tweaked to help all the companies in your portfolio. Work closely with firms to overcome major hurdles, such as finding new suppliers and distributors, and clearly communicate any issues to their core customers.
Small firms might also need additional human resource and technical support to get their employees up and working from home.
3. Seller beware
Private equity survives on hammering out deals, but many mergers and acquisitions are now firmly on ice. Floundering global markets and the lingering prospect of recession means many investors are rethinking the cost of deals they have in the pipeline.
But changing contracts is far from straightforward. Normally, it’s down to courts to decide whether a material adverse effect (MAE) alters the operations of a business or the value of its assets. Until we see how long the COVID-19 pandemic lasts, we won’t know for sure whether the virus will qualify as a MAE and see buyers revamp their acquisition terms. But expect to see rules preventing pandemics or global health emergencies from being included as MAEs.
Until then, private equity funds should pay close attention to the small-print from lenders. Make sure they won’t claim a MAE has taken place and refuse to deliver the money you’ve agreed to borrow to fund your next deal.
4. Go virtual
Scheduled to hold your annual general meeting during the shutdown? Take it online.
The Securities and Exchange Commission (SEC) wants companies and funds to consider hosting their annual shareholder updates virtually. Investors stay up-to-date with the latest developments (and can grill companies); businesses stay on the right side of federal securities regulations. And everyone stays safer.
The SEC is also offering funds a 45-day delay for key filings. Notify the Commission in advance if you need to extra time to file the Form ADV investment advisor registration document or Form PF for assets under management.
Take extra care when tallying up quarterly and end-of-year valuations for portfolio companies as widespread virus shutdowns and a dramatic fall in consumer spending are likely to have a significant impact.
Now is also a good time to recalculate forecasts and rethink future scenarios in light of the current crisis.
5. Look for opportunity
For funds armed with a record level of cash, the current uncertainty could create buying opportunities. Floundering companies might be up for grabs at bargain prices. Struggling investors might be forced to off-load assets in fire-sale deals.
But make sure your due diligence is tighter than ever. “Furthermore, working capital analysis will have to consider not only historical data, but pipeline and the increased pressure on invoicing, collection, aging receivables and payables, as well as negotiations on payment terms and discounts,” Vaccarella said.
Take the new market dynamics into consideration and scrutinize cash flows, market positioning and customer mix before making an offer. Also consider ramping up requirements for representations and warranties to stop sellers ringfencing the effects of COVID-19. And check your target’s emergency preparedness and insurance coverage is up to date and consider how well future disasters would affect its ability to meet commercial contracts.
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