COVID-19 has caught the world off guard and the effect of the pandemic on businesses cannot be overemphasized. Private equity funds (“PEs”) and venture capital funds (“VCs”), like other organizations, will need to adapt to the ever-changing landscape by taking steps to protect their portfolio companies and look to investment opportunities.
PEs and VCs can take proactive steps to shore up the existing fund’s portfolio companies and seek out new investment opportunities that may offer more attractive terms. Some of the strategies that PEs and VCs may wish to take in the current climate are outlined below.
1) Deployment of Capital
PEs and VCs need to consider how they accumulate and deploy capital during the pandemic. The rapid decline in capital markets and economic stagnation could cause difficulties for funds to secure capital from current and prospective investors. Yet, portfolio companies will likely cause the capital requirements to increase. PEs and VCs will need to be strategic in how they deploy capital.
Portfolio Companies: Given the uncertainty in the market, PEs and VCs may wish to review their portfolio companies to ensure they have the required capital and experience to address the current economic climate.
Opportunistic Investment: Although the economic uncertainty caused by COVID-19 could make calculating meaningful valuations of target companies extremely complex, attractive opportunities will exist. Lower valuations due to uncertainty will present potential long-term investment opportunities. Target companies may accept lower valuations and provide more favourable terms given that lack of viable investors. In addition, financially troubled corporations requiring capital to continue will offer unique opportunities. To understand how it may deploy capital, PEs and VCs should review their fund documents to be aware of any restrictions prohibiting it from taking advantage of potential investment opportunities, such as restrictions on its ability to make capital calls.
2) Communicate with Key Stakeholders
PEs and VCs should maintain regular lines of communication with all stakeholders. Taking an active approach to assure investors and portfolio companies during these uncertain times will strengthen relationships and bolster chances of success. Funds may wish to offer guidance to portfolio companies and provide updates to investors regarding their investments and the economy as a whole.
Portfolio Companies: PEs and VCs should communicate with portfolio companies to understand how each company has been impacted. Portfolio companies may seek advice and strategies to reduce cash burn rates and cut expenses in an effort to preserve financial stability and to address declines in revenue.
Investors: Investors will look to PEs and VCs to understand the impact of COVID-19 on their investment. PEs and VCs will need to formulate how and what they will communicate to investors, including how portfolio companies have been affected and the fund’s performance. Additionally, PEs and VCs may wish to gauge investor appetite for further investment through bridge financing at more attractive returns or to explore new opportunities. Funds should be aware of any allocation policies of larger institutional investors that would limit their ability to invest.
Existing Debt Providers. PEs and VCs should confirm they can comply with any financial covenants relating to their credit facilities. PEs and VCs should review its loan agreements to ensure they comply with any obligations to notify of a default or anticipated default under these loan agreements. PEs and VCs should consider confirming their portfolio companies also comply with any covenants and obligations under their respective loan agreements. Based on this review and to address any potential defaults under these agreements, PEs and VCs can determine if any requests for deferral of interest or principal is required.
3) Extend Timelines:
Given the current economic uncertainty, PEs and VCs may need to extend the timeline of the fund to seek investment opportunities and exit existing investments.
Investments: PEs and VCs should recognize that the timeline and cycle of the fund may require adjustment. Commitment periods may need to be extended and fund closing periods be delayed to assist in raising funds. The term of the fund may also need to be extended in anticipation of longer exit horizons.
Waivers and Reporting Requirements under Fund Documents: Timelines in the fund documents may also have to be adjusted to manage waivers and reporting requirements. Current social distancing protocols have dispersed teams and raised communication barriers. PEs and VCs may need more time for investors to consider relevant information and provide necessary waivers. Additionally, funds may require additional time to formulate reports and responses to investors to better understand the impact of COVID-19.
4) Acquiring Capital:
PEs and VCs should ensure they have enough capital to support the survival of portfolio companies and to pursue new investments. The search for varied sources of capital could be crucial as securing traditional sources of financing may be more difficult.
Fund Structure: PEs and VCs should review their governing documents for restrictions that could impede its ability to have the necessary capital on hand. These include restrictions on follow-on investments and on the amount of capital the fund can deploy in a given period. Furthermore, a review of the recycling provisions in governing documents is advised to determine the extent capital can be re-invested so to meet capital requirements.
Traditional Debt: PEs and VCs should explore whether debt financing could help meet the capital requirements of portfolio companies. Timing is critical as banks could become wary to lend if the economic downturn continues or worsens.
Government Programs: PEs and VCs should determine if they qualify for any federal or provincial programs or loans. These include measures introduced by governments to specifically address the financial uncertainty surrounding COVID-19.
Although COVID-19 has shaken the global economic climate, some of the steps outlined in this article can assist PEs and VCs to shore up existing portfolio companies and to be ready for new investment opportunities. Overall, the pandemic represents an opportunity for certain PEs and VCs to adapt quickly and rise to the occasion and thrive.
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