As covid-19’s impact on the economy and society deepens, private fund managers face many challenges, both internally at the management firm level and with respect to portfolio companies. Although we are some way into the global pandemic, fund managers are advised to continue to keep their eye on the ball and take the following steps to best prepare themselves and their portfolio companies for the future.
Timing At this moment, global social distancing measures have made in-person meetings between fund managers and investors impossible, which has greatly complicated customary due diligence. Right now, established fund managers have generally maintained or even accelerated scheduled closings, and this is expected to continue. By contrast, less-established fund managers, and those that are earlier in the fundraising cycle, may face challenges gaining the attention of prospective limited partners, which could be facing their own liquidity concerns.
To prepare for the uncertainties ahead, fund managers in the process of fundraising, or anticipating a launch in the near term, should be prepared and consider extending the fundraising period beyond the conventional 12 months.
Risk and valuation disclosures Fund managers should consider including additional disclosures in their marketing materials and offering documents regarding the potential (and uncertain) impacts of the global pandemic on portfolio companies, funds and sponsor firms. Fund managers should also be particularly vigilant in following their valuation policies and, when appropriate, updating valuations in pre-existing materials – for those that do not yet reflect covid-19’s impact.
Financing flexibility In anticipation of potentially delayed fundraises, managers should review fund documents to determine whether GP affiliates or third parties are permitted to warehouse investments for future vehicles while fundraising is ongoing. If warehousing activities are not permitted, fund managers should consider seeking amendments.
Use of capital Fund managers are advised to consider portfolio companies’ near and mid-term capital requirements in light of changing market conditions. Although funds past their investment period would typically still have the ability to make follow-on investments, managers should review their fund documents for any limitations. For funds that are capital-constrained, managers should consider their flexibility to recycle distributions and, if necessary, consider seeking amendments to provide for expanded recycling capabilities. In addition, managers may also consider GP-led secondary transactions (discussed below), raising annex funds, existing funds or utilising single-asset co-investment vehicles and debt financing alternatives.
Investment strategy The currently depressed public equity markets may create newly attractive investment opportunities – for example, funds that have typically invested in private markets may now find public market valuations attractive. Fund managers are encouraged to review the investment objectives and limitations in existing fund documents to determine whether, and to what extent, existing documents permit the fund to explore these new market opportunities. If such investments are not permitted, fund managers should consider seeking amendments to permit the fund to take advantage of these new opportunities.
Financing Fund managers may be inclined to lean more heavily on capital call lines or other credit facilities currently in place rather than raising capital from liquidity-constrained limited partners. Thus, fund managers are advised to examine the borrowing limitations and reserve requirements under the relevant loan documents – which typically require both the absence of any default and the bring-down of representations and warranties. Fund managers should be prepared to see additional enquiries from lenders relating to the fund’s financial condition, particularly with respect to asset-based credit facilities.
Valuation Fund managers should ensure that valuations continue to be conducted in accordance with their policies. In fact, seeking input from independent valuation advisers on the weighting of methodologies may be prudent in cases in which precedent transaction analysis may not reflect the most current market information.
Portfolio companies Fund managers should be actively monitoring all their portfolio companies and gathering as much real-time information as possible. Fund managers who sit on the boards of portfolio companies must remain mindful of the duties all parties owe to different constituencies. In this economic environment, portfolio companies’ directors must also be especially aware of the rights of creditors, risks and potential scrutiny of their actions – particularly when a portfolio company is considering a corporate transaction such as a purchase, sale, merger, consolidation, infusion of capital or a restructuring, reorganisation or even bankruptcy.
Insurance and indemnification Fund managers should ensure that they have up-to-date copies of all documents that could provide insurance coverage and indemnification to their various constituents. It is particularly important to ensure current documentation at the portfolio company level, as that is often the first source of coverage when an issue arises. Similarly, fund managers should ensure that all portfolio company insurance policies are current and premiums continue to be paid. Finally, fund managers should examine their insurance coverage programme to ensure it is tailored to work in harmony with other existing policies and the indemnification rights and obligations at both the portfolio company level and the fund level.
Information sharing with LPs Fund managers should continue gathering feedback from portfolio companies on the anticipated impact of covid-19 on their operations and performance, and actively communicate with LPs regarding the status of portfolio companies and potential capital requirements.
Secondaries Secondary buyers and sellers have witnessed disruption with respect to existing secondary processes, resulting from fluctuating valuations and liquidity challenges. As markets stabilise in the medium to long term, it is likely that we will see a rise in the level of secondary market activity as investors seek liquidity solutions. Similarly, market dislocations may also present opportunities for GP-led secondaries, particularly with respect to individual portfolio companies in need of additional capital to maximise value in the long term.
Management company operations
Operational considerations Fund managers should continue to review their business continuity plans and document any deviations. At a time like this it is also critical to plan for unexpected absences of key personnel and corresponding disruption. Fund managers should also bear in mind requirements under labour and employment laws, such as those related to occupational safety and medical leave.
Legal developments It is particularly important for fund managers to keep abreast of regulatory developments. The US Securities and Exchange Commission has announced several forms of relief, including extending certain deadlines for investment advisers. Furthermore, in response to the global pandemic, the Coronavirus Aid, Relief, and Economic Security Act expanded two loan programmes administered by the Small Business Administration, the Payroll Protection Program and the Economic Injury Disaster Loan Program. Fund managers should consult with their portfolio companies to gauge their need and potential eligibility for loans under the programmes.
If history teaches us anything, it is that periods of crisis can present opportunities for success. Many of the funds raised in the midst of the financial crisis of 2008 have produced outsized returns. Although the long-term impacts of this global pandemic remain to be seen, fund managers and investors that are diligent and agile are likely to emerge from this crisis in a position of strength and poised for future success.
Howard Beber and Chip Parsons are partners and Ashley Sun is an associate at law firm Proskauer