COVID-19 and Private Funds – What’s Next?
The COVID-19 pandemic has had economic repercussions on all business sectors, and the private equity and venture capital fields have not been spared. Fund managers, promoters and general partners (collectively, “Managers”), on one hand, and limited partners and other fund investors (collectively, “Investors”), on the other hand, must be prepared to face the challenges ahead by establishing an upstream action plan that will limit governance risks and ensure continued success of private funds. Our COVID-19 Recovery Hub presents key information about current, pandemic-related business issues.
This article more specifically explores the nature and extent of the repercussions of the pandemic on private equity and venture capital funds and offers some practical solutions to help promote a successful market relaunch.
Generally, Managers should consider extending certain time periods specified in fund documents, or explore the possibility of seeking consents or waivers from Investors or advisory committees in connection therewith where such flexibility is already incorporated in existing documents. The key is to ascertain whether the fund documents already grant such latitude and, if not, what procedures should be followed in order to amend or derogate from such documents. For example, the following avenues could be explored:
- extending the period for accepting new Investors and raising capital, either at the discretion of the Manager or with the approval of the advisory committee (LPAC), because the usual 12- to 18-month period may not be sufficient in the current economic climate to reach fundraising objectives;
- allowing more flexible timelines for meeting quarterly and annual reporting requirements;
- extending the investment period, which typically ranges from three to five years, in anticipation of a slowdown in the pace of completion of new investments and the limited availability of leverage to complete leveraged buyouts; and
- for funds that are reaching the end of their life cycle, requesting an extension to allow additional time for maturing investments to stabilize in the event of a prolonged financial slowdown.
Investors should consider requests from Managers in light of the relevant circumstances, while keeping in mind their own investment restrictions and strategies, which may not always align with Managers’ intentions.
Supporting Portfolio Companies
Managers and Investors should consider loosening certain restrictions in order to be able to better support portfolio companies in the foreseeable future. Indeed, it is highly likely that several portfolio companies will require additional capital to secure a successful market relaunch or, in certain cases, solely for the purpose of pursuing their operations. With this understanding, Managers should adjust their portfolio strategy, assessing the limits that apply to their funds with respect to constraints on the amount and timing of investments. Consideration could also be given to:
- discussing with portfolio companies’ operators the availability of other sources of funding, including COVID-specific governmental assistance tailored to small- and medium-size businesses or to industry sectors (see our article re: COVID-19: Recovery and Re-opening Tracker);
- increasing the limits on guarantees provided by the fund to secure loans needed by portfolio companies;
- increasing the limits on capital recycling and follow-on investments in existing portfolio companies; or
- providing greater flexibility for Managers to hold on to, and not distribute, capital received from portfolio companies, given that some Investors may have limited capacity to contribute capital.
Maximizing Cash Flows Through Borrowings
With a focus on increasing cash availability, Managers should review the borrowing limits set out in the fund’s governing documents to assess whether the borrowing capacity is adequate in light of the current environment. Portfolio companies will likely require additional capital support and the risk of Investors defaulting on capital calls are likely to increase.
With the potential liquidity problems ahead, it could be worth considering limiting redemption mechanisms (if any) in the fund’s governing documents, or even suspending them. These redemption limitations can be effective safeguards to mitigate the impact of increased redemptions on the value, cash and concentration of a fund’s portfolio, as witnessed in the months following the 2008 financial crisis. In such cases, Managers will need to review the fund’s governing documents to check whether it is possible to limit or suspend redemptions.
Investing in distressed assets can be bold, but can also be very profitable – it is, however, important to review the applicable investment restrictions beforehand to determine whether the fund has the right to deploy capital in certain asset classes and, if not, what consents are required to amend the scope of the investment policies when appropriate.
It may also be advisable to consider deferring the fund’s annual meeting or holding a virtual meeting, which may again require a waiver of or amendment to the fund’s governing documents, although private equity and venture capital funds generally have fewer technical requirements than public companies (see our article re: Going the distance… or not: How holding virtual AGMs can help Canadian issuers navigate the COVID-19 crisis on this subject). If you choose to proceed with a virtual meeting, make sure to test the platform beforehand to ensure smooth operation.
Duty to Disclose Information
Overall, the most important thing in this period of uncertainty will be to keep Investors informed – open and transparent communication is key. Managers should be alert to additional disclosure requirements that are sometimes included in side letters, and examine the impact of COVID-19 by modeling potential recession or market downturn scenarios in order to be prepared to answer questions from Investors who have legitimate concerns about the impact of the pandemic on the fund and on their investments in general. Even if not required by the fund’s governing documents, it is good practice for Managers to hold more frequent virtual or telephone meeting with Investors to update them on the status of the fund’s portfolio and to answer their questions.
For Managers who are in the process of forming new funds or raising additional capital for existing funds, it may be advisable to review all existing disclosure to prospective investors and to update such disclosure in light of the additional risks caused by the COVID-19 pandemic by issuing a supplement to the fund’s offering memorandum (OM) or private placement memorandum (PPM).
It is clear that a good understanding of the terms of fund documents, side letters and other agreements will be essential in a market shaken by COVID-19. Managers will need to take particular care in handling liquidity and ensuring fair treatment of Investors. The most important thing for both Managers and Investors is to keep an open mind and adapt their current or upcoming fund documents in light of the lessons learned from the current pandemic.
This blog post is part of our ongoing efforts to keep you informed about COVID-19. Check out our COVID-19 Recovery Hub for real-time updates.