What an interesting time it is for Private Equity firms and for the firms that are looking for PE investment.
Today we’ll look at the implications for PE.
From our discussions across the US, Canada and Asia-Pacific, PE firms report that 80-90% of their portfolio companies are OK or at least have enough cash preserved for the next 6-12 months. Note, like the general economy, this doesn’t mean they are thriving, but rather the portfolio companies’ plans can be scaled down with the aim of growing again when the market will be better in 6-12 months.
Some portfolio companies are also doing well and in some unpredicted exceptions, doing even better during COVID than planned, but these are a minority.
Acquisition Opportunities for Private Equity Firms
PE firms are also reporting that they are being inundated with acquisition opportunities, including:
- Opportunities to invest in current portfolio companies at lower prices
- Opportunities to buy competitors or bolt-ons at lower prices
- Opportunities to buy smaller funds
- Opportunities to co-invest in other businesses owned by PE, looking for support
However, and this is the interesting part, how will PE take advantage of these opportunities? Where will they get the money?
The obvious answer for some is that they have the money on tap and are all set. This is a great position for a minority of funds and we expect that even these firms will be cautious in deploying capital.
However, the reality for many funds is they are keeping whatever funds they have to support portfolio companies and so to take advantage of new opportunities they need additional investment capital or debt.
The challenge on the investment side is that most PE Funds are not planning to raise money for new investment in the next 6-12 months because they don’t think it will work. Where they see great opportunities for their LPs, they have been told there will be support, but they expect the pricing will be lower and the timing more drawn out.
So that leads us to debt. As you know most PE deals rely on debt and PE are reporting that while their traditional lenders are very supportive of their current positions and investments, they have indicated new debt will be much more difficult/unlikely to access. This is especially the case in Asia-Pacific where the range of local lenders is much smaller.
What are the potential implications for Private Equity firms?
- If Funds can’t access investments or capital there will be less deals, less transaction bonuses and so smaller PE Funds will be looking to reduce overheads and even merge with other funds
- Fund raising for many will be put off for 6 – 12 months (maybe longer) impacting the growth and potential exits of portfolio companies and returns to LPs, so funds will be looking for cash and new ways to get payments back to LPs
- Debt for new investments will be much more difficult to access and so PE will need to look wider (overseas) than their traditional sources
- Debt leverage levels will be more conservative, reducing valuations and making it more difficult for PE to outbid strategic buyers
- PE will need to exit some assets to secondary buyers to have funds to focus on their core preferred assets
How can PE firms take advantage of Net Asset Value Loans?
One solution we have been discussing with funds is Net Asset Value (NAV) Loans that enable funds to gain debt based on the value of their whole portfolio to be used as they see fit.
NAV loan structures are particularly useful for funds that are near, or past, the end of their investment period and are also helpful to take advantage of “opportunistic” deals that have recently emerged.
NAV loans can accommodate a diverse variety of circumstances and accordingly are keenly negotiated. Typically, however, they are structured in the following manner:
- The borrower is either the Opco, Holdco, or Fund and the NAV loan is guaranteed by the Fund.
- NAV loans can be 10% – 30% of the value of the fund’s eligible assets, which are generally limited by concentration limits and diversity requirements. Valuations are conducted by the Sponsor on a quarterly basis.
- Coupons of ~ 8-12%, payable in a combination of cash and PIK interest (can be all PIK).
- No stated amortization. Maturities up to 5 years.
- Prepayment penalties in the first 12-18 months.
- No financial covenants at the portfolio company level, but negative covenants that can include limits on additional fund-level guarantees, debt, and the sale of assets outside the ordinary course of business.
You can download the NAV Summary here.
*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC.
If you have a current or prospective liquidity need and would like to discuss the concept of NAV loans further, please reach out at any time.
Charles Harvey
Principal, Austin
Charles is a Principal of Eaton Square. He spent 35 years as CEO, CFO and consultant to the Fortune 500, Middle Market, Mainstreet and in the Start-up community, including spending time at PepsiCo & Price Waterhouse Coopers.
