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“Bridge over Troubled Water: PE in a Time of Crisis”


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History has seen local lockdowns due to a disease or virus (some echoed in literature such as in Boccaccio’s “The Decameron” or Defoe’s “A Journal of the Plague Year”), but unprecedented is the truly global dimension of the Covid-19 crisis, which affects industries, including PE, on a worldwide scale.

Thanks to its both flexible and stable legal, tax and regulatory environment, offering both regulated and unregulated structures, Luxembourg is recognised as a major hub for the PE industry. With a presence of the world’s top 19 PE houses, and around EUR400 billion of assets under management, Luxembourg takes a vital interest in the industry’s well-being and development.

PE firms and their portfolio companies have benefited from the growth in fundraising, valuations and transaction volumes in recent years and may face the crisis in a position of strength. High levels of deal leverages and multiples paid might yet prove as fault lines. It is thus worthwhile to take a closer look at the status quo and possible challenges and opportunities for PE amidst this crisis.

Fundraising and Fund Terms

The demand in fundraising is reported to maintain a solid level. In a recent survey, only a minority of fund managers raising PE investor capital indicated that they would pause the fund raise indefinitely or abandon it. The launch of new funds was widely expected to be delayed by at least a few months. Potential LP liquidity issues do not seem to be a primary concern either.

GPs in the process of investing fund capital appear to hold steady on their fund investment, without seeking extensions to commitment periods or fund terms. Luxembourg fund documentation generally allows fund managers to delay the start of the investment period or the disposal of certain assets in the divestment phase or to extend a fund’s life duration under certain conditions. A temporary suspension of the calculation of the NAV or of redemptions or subscriptions may be further available options.

Dealmaking

Dealmaking has seen a substantial contraction since the beginning of the crisis. GPs focus on the challenges and look at stabilising their portfolios. Sellers, in turn, are hesitant to divest assets that have significantly dropped in value, while potential buyers may speculate for further falls in prices. The market uncertainty and volatility has led to a mismatch in buyer and seller expectations, with transactions having been disrupted for that reason.

PE funds sit on record levels of dry powder that is waiting for investment. Distressed debt investors may take the lead in view of decreasing asset valuations. Private debt funds might provide financing to businesses with short-term liquidity issues or for new deals. And with other market players potentially conserving their liquidity, PE may have an edge in the competition for attractive targets.

For ongoing transactions, it needs to be assessed if and in what form the crisis might have an (adverse) effect on the target’s business and how the impact could be quantified and addressed in the legal documentation (e.g. purchase price adjustments, retention amounts and seller guarantees).  

A New Reality in the Making

With the pandemic having sparked off a lot of financing, alternative investment will likely play an increasingly important role in the market. Financing needs may be considerable as industries come under pressure despite funding programmes. However, PE firms need not only consider the financial aspect of investing, but the value they can add to the companies they invest in and their transformation.

Covid-19 is expected to be a catalyst for environmental, social and governance (ESG) considerations, in respect of how PE firms run themselves and their portfolio companies. Transparency will be another aspect PE firms should focus on. GPs stated that LPs have started asking for more frequent reporting notably on portfolio company revenues. Market updates and other relevant communication with LPs will help increase the credibility of in-place risk management.

And new technologies and digitisation are not only considered as key drivers for greater transparency and improvements in operational processes (including risk strategies) but may also create investment opportunities PE will benefit from as well. The result may be a shift in investment targets, which could place companies e.g. in the tech, software or life sciences sector further in the limelight.

Conclusion

The pandemic will no doubt reshape the PE industry. The threat may have been diminished, but recovery is lingering. PE firms managing their portfolios right are bound to benefit.

Luxembourg will play its role in these “new normal” times: The regulators have been perceived as approachable and pragmatic, the legal toolkit and know-how is here to stay and rating agencies recently underscored Luxembourg’s capacities to deal with the crisis and maintained the country’s AAA rating.