Over the last 4 weeks, in the face of COVID-19 the worldwide economy has experienced the sorts of pressures not seen since the Great Depression. Businesses around the world have been forced to close their doors; we have seen government interventions which, only 3 months ago, would have been unthinkable; and terms such as "social distancing" and "furloughing" have become common parlance.
Whether or not all of this will result in a seismic shift for the private equity industry in the longer-term remains to be seen, but as dark clouds gather once again liquidity is the number 1 priority for GPs and fund managers. Whilst new deals are largely on hold, with global M&A activity for Q1 2020 down 28% year-on-year, GPs and managers are urgently assessing the potential additional funding requirements of their existing portfolios to ensure they have sufficient firepower to inject cash where it's needed. Older vintage funds, where there is significant NAV at risk and (perhaps) little remaining by way of uncalled investor commitments, are particularly exposed.
We have seen a significant uptick in enquiries from GPs and managers, investors, lenders and the wider advisory universe about the tools available to provide that liquidity. Step forward NAV facilities and preferred equity products, whose day (or, perhaps more realistically, year) it is in the sun. From a practical perspective, is there going to be enough capital available to cover the GP-demand for products of this nature? Our (and the wider market's view) is that there will not be, so first mover advantage could be crucial.
- Is LP/LPAC consent required under the fund documentation to put such a product in place and/or are there any relevant borrowing/guarantee restrictions to be adhered to? If so, how are LPs likely to react, what is the consent threshold in order to proceed and what impact will this have on timing? If not, or the product can be structured to avoid such consent, are there nonetheless IR concerns which need to be addressed as part of the process?
- What is the regulatory position and, in particular, will putting such a product in place cause a previously unleveraged fund to be leveraged for the purposes of AIFMD? If so, what impact does the need for FCA approval have on timing?
- How will any security package be structured – in particular, is there an aggregator vehicle over which share security can be granted (or, if not, can the underlying assets be transferred to such a vehicle) or will the fund have to give local law-governed share charges over Topcos incorporated in jurisdictions across Europe/the globe? Will any of these options cause issues under any relevant underlying investment or shareholders agreements?
- How will the liquidity provider value the underlying portfolio for the purposes of sizing the funding it will make available and calculating LTV, both on day one (particularly given current valuation difficulties) and going forwards? What is the maximum LTV it is prepared to fund against?
- How will the liquidity provider assess which investments are "eligible" to be included for the purposes of the LTV covenant, both on day one and going forwards? The traditional approach of immediately discounting investments which are in default or forecasting a covenant breach under the terms of their underlying finance documentation is unlikely to be fit for purpose.
- What are the consequences (and applicable cure rights) following a breach of the LTV covenant?
- What due diligence (commercial and legal) can be offered? Can any due diligence be front-loaded to aid timing?
- What effect does the form of funding have on the tax position of the fund, both at the outset and on unwinding?