What PE-backed companies can expect from their investors

Private equity companies are working on the changes that need to be instigated in the light of the ongoing Covid crisis. Some of the changes will affect portfolio companies, including those in the technology, media, telecoms and life sciences.

I have spent the last many weeks in close contact with companies and investors, including PE firms. One of the things that have struck me is how private equity companies’ Covid-19-related actions and considerations mirror answers and insights from 2019’s inaugural  BDO U.S. Private Capital Outlook.

Amongst the report’s findings were that PEs were preparing for longer holding periods and that technology remained an area of great promise. Furthermore, PEs were planning to focus more effort towards supporting portfolio companies. Now, Covid-19 has turned the dials on all of those plans up to the proverbial 11.

However, many other aspects of the ongoing Covid-19 crisis came as a complete surprise to both PEs and their portfolio companies. BDO is advising clients and companies, including PE houses and their portfolio companies, on how to minimize the economic fallout from the crisis and access relevant aid programmes where possible. We have also launched a global Covid-19 Crisis Hub to help keep our clients informed and up to date.

One area of particular interest to PE’s portfolio companies is the short, medium, and long-term changes that may arise in their relationship with PE investors. Furthermore, they are looking to find the best, most proactive ways of collaborating with PEs both during and post-Covid-19.

Short-term changes

The immediate situation for PE houses and their portfolio companies is focused on risk and exposure mitigation. This covers both the virus itself and economic exposure. Many PE houses have dedicated in-house teams working hard on supporting portfolio companies. Some of the areas where portfolio companies may look for support include:

Employees and operations: In the short term, there will be a focus on ensuring that employees are not exposed to the virus and that operations can continue as best as possible. PE’s will look to encourage and support work-from-home arrangements and remote work options. For international companies, there may be ways of shifting essential tasks to areas less affected by the virus.

Communication: Communication levels between PEs and portfolio companies will generally be higher during and after the crisis. Both parties should be looking at keeping each other abreast of their situation and collaborate to mitigate evolving exposures and risks.

Stopping deals and investments: Through talking to industry insiders on a daily basis, it is clear that PE firms are looking to stall most deal activity in the short term. If you are waiting for additional investment, you will likely have to wait a bit. That includes further investments toward bolt-on deals. However, new funds are still closing, and we expect to see a marked uptick in deal and funding activity on the other side of the crisis’ immediate impact.

Focus on liquidity and agreement structures: PEs will be focused on cash flow and liquidity among portfolio companies. Areas to consider will include weekly cash flow analyses, collections analysis, short-term loan options and possible loan restructuring. Furthermore, liabilities and possible insurance issues will be focus points, as will how to treat operating losses in relation to loan covenants.

Identifying tax issues: Tax issues may arise due to changes in performance and potential restructuring of finances and loans. Furthermore, possible access to aid and relief structures may impact the tax liability of both portfolio companies and their PE investors.

Medium to long-term changes

At the moment, the changes and challenges make every week feel like an entire era in corporate history. On the other side of the immediate aftermath, further changes await PEs and their portfolio companies. While deal and financing activity will start to resume, we expect to see average multiples fall to lower than before the crisis. Companies who have had high valuations during – and in part because of – Covid-19, such as Zoom, may see valuations retreat as well. During this time, changes to PEs and their expectations of portfolio companies may include:

Identifying strong sectors: One example will be a re-evaluation by PE investors of what companies and sectors represent particularly promising investment opportunities. Medtech, unified communications, 5G, cybersecurity and retail tech are areas that will have strong arguments for why they will see growth in the short to medium-term on hand due to Covid-19.

Changing due diligence parameters: Currently, granular forecasting is impossible – perhaps unless you have access to a crystal ball the size of a planet. Companies can expect changes to the value attributed to various aspects covered in a due diligence process ahead of financing. The resiliency of a target company’s business model is likely to receive much more attention.

Identifying changes to customers: PE houses will expect portfolio companies to look to identify changes in their customer segments. The analysis should cover both the economic, behavioural, and value-set changes that customers may have undergone due to Covid-19. Furthermore, it should incorporate plans and strategies for how to meet those changes.

Changes to company strategies and structures: PE houses will expect companies risk mitigation strategies to cover workforce mobility. Investing in remote work solutions, where applicable, will be a priority. Integrating other technologies that can increase company resilience will also be a priority. The same goes for updating strategies and business structures, including crisis management plans.

Longer holding periods: As we found in our survey, PE investors were already preparing for longer holding periods for portfolio companies. The crisis could likely extend that even further. Longer holding periods means that companies can expect a re-evaluation of capital investments, profit targets, etc.

Refinancing and restructuring portfolios: PE houses may come out of the crisis holding distressed assets that will need cash injections. There could also be changes to the needs and services offered of said assets. During the refinancing and restructuring of portfolios and portfolio companies, all parties must keep a keen eye on taxation and liabilities to get the best starting point for taking advantage of the opportunities that are likely to arise in the wake of the current crisis.