Allocators need timely asset and market prices to effectively make portfolio management decisions. While some private equity and venture capital investors see the lack of frequent valuations as a positive characteristic, access to timely information is especially important where there appears to be a regime shift in markets, and the COVID-19 pandemic certainly qualifies for that.
Private capital investors are rightly asking themselves “should I top up my exposure to private capital?” or “should I reduce it via the secondary market?”
Direct investment portfolio companies are typically only independently assessed annually. Fund managers do provide more frequent interim quarterly valuations, but these do not always match the economic reality for the companies being valued as managers retain discretion to ‘‘smooth out’’ valuation volatility.
The COVID-19 shutdown has disrupted middle-market private equity mergers and acquisitions as it has the rest of the economy.
For many middle-market sponsors, focus over the last few months has been on managing the crisis and preserving value at existing portfolio companies, but funds continue to hold record amounts of dry powder.
The pressure to deploy this capital exists across the market, including those with recent fund closings and mature funds seeking to deploy the last of their committed capital.
Because of COVID-19, many companies remain in dire need of liquidity, including sponsor-owned portfolio companies that have a proven business model and established profitability. A source of capital may be sponsors who participated in auctions, either as an unsuccessful bidder or a bidder in a stalled auction. Such sponsors have already vetted management and conducted thorough diligence, and in many cases, deals were fully negotiated and parties were ready to sign an acquisition agreement.
The longer-term impact of COVID-19 on private capital dealmaking is still unclear, but with challenges, there will inevitably be opportunities for proactive sponsors.
- For many sellers, planned or current sale processes have been put on hold or slow-tracked. This pause has extended to the middle market. Even as lockdown restrictions ease and public markets start to rebound, many sellers expecting buyers to demand lower post-COVID-19 pricing will continue to defer an exit until valuations recover or some sense of longer-term stability exists.
- For buyers who remain active, many have struggled with the practical difficulties of conducting traditional due diligence, lack of in-person access to management, and restrictions on travel and scheduling required for physical site visits. While some buyers may initially seem willing to work through these issues, a remote process could stall deals due to roadblocks that, under different circumstances, might be resolved with face time among buyers, sellers, and management teams.
- While direct lenders have filled some of the gaps caused by bank-lender reticence, the most significant and continuing challenge is that access to private debt is considerably tighter. In many cases, deal timelines for both new platform and portfolio company add-ons have become protracted with extended exclusivity or diligence periods in the absence of competitive auctions.
- Despite recent market rebounds and optimism about recovery, a key issue faced by both parties and lenders remains risk allocation and valuation.