Will Private Equity Firms Emerge Unscathed from the COVID-19 Crisis?

Published on 28 May, 2020

COVID-19 has negatively affected almost all sectors of industry. Many bore the brunt of the pandemic, with lockdowns and restricted travel ringing up losses. The private equity business is no exception; many ongoing deals, and several more in the pipeline, are now paused. The business, which was on the upswing, will now be hit due to this turmoil. However, there are some factors favoring the PE space. If participants can take steps in the right direction, they may be able to emerge from this crisis with minimal damage.

The unprecedented scale of the COVID-19 pandemic has caused social, economic, and geopolitical imbalance worldwide. The rapid spread of the virus across the globe has forced countries to seal borders and order lockdowns within their perimeter. The need for social distancing has thrown economies into a tailspin and recession is slowly creeping up on countries and sectors.

Private equity (PE) deals are yet another segment of business to be hit by the pandemic as companies grapple to survive the situation. Investments and deal activities in upcoming months might decline in terms of value and volume. In this time of uncertainty, funds are obviously wary of mis-stepping, pushing back or even halting new deals. They are now focusing on current investment portfolios to maximize returns.

PE firms are rich in cash, sitting on a pile of US$2.4 trillion of dry powder, enough to maintain the existing portfolio and also to deploy capital at attractive valuations. Transaction volumes would slow down and ongoing deals are likely to generate capital calls soon.

PE Dry Powder ($ billion)

Source: Preqin

Both buyouts and growth equity will be affected earlier than other markets due to their higher correlation to public markets. Companies and industries with recurring revenue models, as opposed to transactional revenue models, will likely fare better, at least in the short term. Small companies will be the most challenged to survive a sustained downturn.

The private markets industry has amassed $2.4 trillion in dry powder, primarily concentrated in buyout strategies

Source: Cobalt as of 9/30/2019

PE firms and their portfolio companies come into the crisis riding a decade-long wave of growing transaction volumes, valuations, and fundraising. This position of strength may prove a bulwark in the months ahead, especially for firms that have recently exercised prudence. Seeing the decrease in deal count after Great Financial Crisis, we expect this trend to re-emerge in the post-COVID-19 era. Due to the lockdown and limited business activities, deals will surely slow down, following the trend of GFC.

Global buyout deal count

Notes: Includes add-ons; excludes loan-to-own transactions and acquisitions of bankrupt assets; based on announcement date; includes announced deals that are completed or pending, with subject to change
Source: Dealogic

Global Private equity buyout volumes hit post-financial crisis high
Deal value, year-to-date($bn)

Source: Refinitiv (formerly Thomson Reuters)

During these tough times, PE firms need to winnow their portfolios and determine which companies need immediate course corrections.

Defensive strategy for PE firms

  1. Assess investment strategy and asset allocation – Changes in financial markets and equity valuations are reason enough to reassess portfolios. Firms holding dry powder can explore investment opportunities that may turn out more profitable. Debt or rescue financing will be popular as many companies suffering in the aftermath of the pandemic may be seeking support. PE firms should consider investing in those companies that have weathered these tough times well due to their disruptive nature. An agile process is needed to quickly grab opportunities when they arise.
  2. Limited partners and stakeholders – Due to the unprecedented nature of the crisis, limited partners (LP) will look at investment managers for support and guidance. PE firms can help with risk management and preparedness to handle adverse situations. They should also ensure that all stakeholders are adequately informed about the trouble companies are facing and have a plan of action to deal with these issues.
  3. ESG investment – The humanitarian aspect of this pandemic has forced an evolution of customers’ expectations from businesses. Firms should evaluate their commitments to environment, social, and governance (ESG) related investing. As responsible corporate establishments, they can gain more support from their stakeholders.
  4. Priorities of PE firms – The priorities of PE firms are as follows.
    • Ensuring safety of workforce without compromising productivity – Firms would require strong technical infrastructure that can support the work-from-home (WFH) initiative. All team members should have access to the issue management and escalation matrix to ensure seamless management of activities. Open communication channels will also enable the workforce to be productive, even if they are not on site.
    • Managing financial risks, liquidity crunch – PE firms must assess financial stability based on the latest economic outlook. Companies should have their financial experts develop a cash management strategy and review liquidity and repayment risks. This can help companies monitor their financial situation.
    • Streamlining operations – Maintaining supplier chain transparency, estimating inventory, and optimizing the limited production levels are steps needed to streamline operations. Companies must safeguard employees’ health, but also deliver on customers’ expectations.
    • Communicating, remaining connected with customers – Communicating with customers is critical in the current scenario. Informing customers about the company’s practices related to COVID-19 and sharing situational communications would be effective methods to remain connected.
    • Preparing for resumption of activities, aligning company for further growth – It is essential for companies to reassess overall strategy and align budgets and goals to the current environment; they need to review and prioritize capital investments. Companies must develop a post-recovery exit plan and also explore growth prospects.

Every industry will be faced with some hard-hitting decisions in the wake of the pandemic. If PE firms can devise and implement robust strategies, they can get through the crisis without too much detriment. The steps mentioned here can guide them in taking a systematic route and readying themselves for the new normal that will set in after the pandemic fades out.