Private Equity Investing and the Pandemic

Join Mintz and leading private equity investors as they discuss how the industry has been impacted by the COVID-19 global pandemic. The candid conversation will focus on the advice investors are currently giving their portfolio companies as well as how deals may be structured as investment activity resumes.

Key Takeaways 

What did they tell/are they telling their companies to do immediately?

• First and foremost, take the steps needed to protect the health of your employees.  Given the nature of their portfolio companies, the move to remote working in general went smoothly and quickly.
• Revisit the plan, as things certainly have changed.
• Cash is king.
• Unfortunately for the individuals implicated, some strong talent will be coming to the marketplace.  Considering that one of the largest challenges to date had been the competition for talent, now is the chance to add to the team.

Should companies have planned better for this?

• Short answer is that this is such a unique situation that it would be very tough to have fully prepare for this, realistically.
• The rate of change was astonishing and caught people by surprise.  Things were hitting so fast that one comparison used was that when this first hit, one hour was the rough equivalent of one business day. 
• Notwithstanding that it would have been tough to have prepared for this, companies need to get out of the trap of reacting to the moment and instead focus on planning for what is next. 
• Moving forward, companies should give thought as to how such an event could impact them and what their plan for the contingency may be.
• Local supply chain redundancy will be something that is considered more closely moving forward.

The impact of historic levels of dry powder currently held by private equity funds.

• In general, given the historically high level of dry powder, the industry as a whole is better able to withstand the crisis.
• However, it inevitably will vary for each fund. 
• Funds that recently raised capital are well positioned and in fact can explore deals with lower valuations and opportunities to do roll-ups.
• For firms that haven’t raised funds recently, things will be more challenging as there inevitably will be a slowdown in fundraising.
• Would expect to see at least some level of adjustments, such as amendments to the recycling provisions, the formation of supplemental funds, etc.
• The tremendous amount of dry power is not going away anytime soon, so there is no rush to exit from solid companies.

Is this an opportunity to be aggressive?

• There definitely will be interesting opportunities for investments arising out of this.  Some of the best investments are done during or shortly after a crisis.
• Depends on the specific company and sector.  In general, they can be characterized as (a) not overly impacted/potentially benefitted (e.g., food supply, distance-learning, tele-health, etc.); (b) companies positioned for a V-shaped recovery (e.g., once the situation stabilizes, once they show a few good quarters they could rebound nicely); and (c) companies positioned for a U- or L-shaped recover (e.g., will need to show many quarters of recovery).  The category a company falls into will impact how aggressive it should be.
• “EBITDAC” (earnings before interest, tax, depreciation, amortization and COVID) will take on meaning.  Will be interesting to see if COVID-related items will be add-backs and will be an even greater focus on quality-of-earnings.
• The situation has allowed PE firms to engage in private conversations with company executives, and this will enable deal opportunities to arise without having to go through a full-blown sale process.
• Of course, there will be opportunities arising with distressed assets.

There currently are mechanical challenges to doing a deal.

• It definitely is and will continue to be harder to complete a transaction.
• Will entail a lot of Zoom calls, extensive use of VDRs, etc.
• Diligence always is important, and now will include deeper dives into certain areas, such as the quality of the customers – are the customers creditworthy?  Can they pay their invoices?  Are they willing to do so?
• Companies that have distant supply chains will find it tougher to engage in transactions.    

Impact will vary on the type of transaction; multiples may be somewhat sticky.

• In the very short term, most good businesses won’t be for sale right now, and you can’t buy what’s not for sale.
• Based on this, the next quarter or two will be tilted towards distressed assets.
• However, firms should be “aggressively opportunistic” – there are always sellers who are selling for non-economic reasons (e.g., family- and founder-owned businesses).
• In addition, there will always be some level of M&A activity on the part of strategic acquirers where they are looking to acquire IP that has strategic value.  These deals will bounce back quicker, in terms of both volume and multiples for valuation.
• Sales to PE buyers might not come back as quickly until there is some clarity on the health situation.
• Alternative acquirers, such as family offices and evergreen funds that don’t have a traditional hold period, may have opportunities to differentiate themselves.
• Private company multiples historically are very resilient, and the current public company multiples suggest that this crisis will not be an exception.
• In furtherance of that, the historic levels of dry powder may also reduce the decline in multiples.

Deal terms also will be impacted.

• For the foreseeable future, lending availability will be more limited and this will require alternative approaches to the financing, and terms and conditions, of deals.
• Lower leverage ratios will impact valuations.
• Expect an increased use of earnouts to bridge the difference in perceived value of a business.
• Other tools, such as seller financing, also will be deployed.
• In addition to potentially requiring an exclusion for COVID-related items, parties can expect the diligence process for R&W insurance to be more robust.
• Likely also will be increased scrutiny on insurance packages overall, including workers’ comp and healthcare insurance.  

Certain sectors will thrive.

• There always has been a lot of hype about tele-health, but it had been growing somewhat slowly.  The crisis is removing the barriers to the growth of the industry, and this will be a hot industry.
• Other growth areas likely will include home-monitoring, remote access, and distance learning.

Fundraising on the part of funds will be more challenging in the short and medium term. 

• It will be important for sponsors to demonstrate transparency will their LPs. 
• Constant communication is required.
• We may see LPs less focused on co-investment opportunities.