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 and take swift action to ensure that they can protect their existing investments and take advantage of investments opportunities that arise in the new landscape.
PEs and VCs can take proactive steps in the light of the pandemic and potentially impending recession to shore up the existing fund's portfolio companies and seek out new investment opportunities that may offer more attractive terms. This article will discuss some of the strategies that PEs and VCs may wish to take in the current climate.
1. Deployment of capital
PEs and VCs will have to carefully consider how they accumulate and deploy their capital during the pandemic. The rapid decline in capital markets and stagnation in the economy as a whole will likely make it harder to secure capital from the current and prospective investors in the fund. Yet, the capital requirements of existing fund portfolio companies may be increasing during this slowdown due to a myriad of factors. This means that PEs and VCs will need to carefully plan how they intend to deploy capital in the market to take advantage of new opportunities.
Portfolio companies: Given the uncertainty in the market, it is advisable that PEs and VCs review the companies in their portfolios to ensure that they have the required capital and experience to deal with the current economic climate. Portfolio companies will likely require the support and guidance of advisors to understand how they can adjust strategies and reduce burn rate to counteract the decline in revenue they may face.
Opportunistic investment: Although the economic uncertainty caused by COVID-19 likely means that calculating an accurate valuation of a company is extremely complex, PEs and VCs should still look for opportunities in the market. Lower valuations and uncertainty will present potential long-term investment opportunities. Companies are likely to accept lower valuations and provide more favourable terms given that there are a limited number of investors and there is uncertainty in the market. There are countless examples of successful start-ups that were founded in the last economic recession of 2008. In addition, there will be opportunities to invest in financially troubled corporations which require capital to continue. To be ready to invest in these opportunities, PEs and VCs should review their fund documents to determine if there are any restrictions prohibiting the fund from taking advantage of potential investment opportunities, such as restrictions surrounding its ability to make capital calls.
2. Communicate with key stakeholders
PEs and VCs should open and 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. This would include offering hands-on advice and guidance to portfolio companies, and keeping investors up to date with the status of their investments and the economy as a whole.
Portfolio companies: PEs and VCs should maintain open lines of communication to understand how each company in the fund's portfolio has been impacted. Portfolio companies may look for advice and strategies including reducing cash burn rates and cutting expenses in an effort preserve financial stability.
Investors: Investors will look to the 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 the impact of the pandemic on portfolio companies and the performance of the fund. Additionally, PEs and VCs may wish to gauge if investors have an appetite for further investment through bridge financing at more attractive returns or to explore new opportunities in a market with lower pricing. However, before broaching the subject, the fund 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 ensure that they are still complying with any financial covenants that relate to their credit facilities. PEs and VCs should consider reviewing any loan agreements to ensure that they comply with any obligations to notify of a default or anticipated default. PEs and VCs may wish to consider ensuring that their portfolio companies are complying with any covenants and obligations under their loan agreements. PEs and VCs can then determine if any requests for deferral of interest or principal may be required for either themselves or any portfolio company so to avoid being in default under these agreements.
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 need to be adjusted. PEs and VCs may be able to extend the commitment period and delay fund closing periods to both seek funds from existing investors and also attract new investors. 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, PEs and VCs may want to allow more time for reports to investors including reports addressing the impact of COVID-19 on their portfolio companies.
4. Acquiring capital
PEs and VCs will need to ensure they have enough capital to help portfolio companies survive and to pursue new investments. The search for varied sources of capital will likely be crucial as traditional sources of financing may be more difficult to secure.
Fund Structure: PEs and VCs should review their governing documents for restrictions regarding follow-on investments and on the amount of capital the fund can deploy in a given period in anticipation that their portfolio companies will likely need capital. Furthermore, they should review recycling provisions in these governing documents to determine if funds can be re-invested to a greater extent to meet capital requirements.
Traditional Debt: PEs and VCs should explore whether taking on debt is a viable strategy to meet the capital requirements of portfolio companies. It may be paramount to act quickly given that banks could become wary to lend if the economic downturn continues or worsens.
Government Programs: PEs and VCs can search and determine if they qualify for any federal or provincial programs or loans which can be used to support the business. This includes measures introduced by governments to specifically address the financial uncertainty surrounding COVID-19.
Although COVID-19 has shaken the global economic climate and may lead to long-term consequences, PEs and VCs can take proactive steps in ensuring their current investments are able to survive these times. Additionally, there may be opportunities for new investments in industries that are able to exceed performance expectations in the current market conditions. Overall, the pandemic represents an opportunity for certain PEs and VCs to adapt quickly and rise to the occasion and thrive.
Miller Thomson is closely monitoring the situation around the COVID-19 pandemic to ensure that we provide our clients with the appropriate support in this rapidly changing environment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.