Crisis Support
Measures for
Portfolio Companies

The rapid escalation of the coronavirus outbreak and ensuing lockdown is having an unprecedented impact on businesses and individuals across Europe. At the same time as they are dealing with the growing public health toll, governments and their advisors are grappling with the enormity of the economic impact of the crisis. The UK’s economic think tank, the Office for Budget Responsibility, indicated earlier this month that the economy could shrink by up to 35% in the second quarter. Data from around Europe point to equally worrying downturns elsewhere. France’s economy is reported to be running at around 65%, while ECB President Christine Lagarde said that each month of lockdown wipes 2-3% off Eurozone GDP.

The hope is that a short sharp shock will be followed by a quick rebound. However, in the interim, there will be a period of intense pain for companies. Policymakers are drawing up initiatives to help businesses survive the crisis. The UK Government has implemented “unprecedented” economic measures and EU Finance Ministers recently agreed a €500-plus billion package, including loans and employment support, supplementing member states’ loan guarantee funds and state aid.

Click Here to Read our Latest Report on Government Support

Usually slow-moving authorities are advancing with new haste, but it is unclear how much access private equity-controlled businesses will have to state-backed schemes. A recent survey from a leading industry body of more than 700 private equity portfolio companies, together employing over 160,000 people in Europe, found that just 29 had managed to access state support. The British government, for one, has clarified that its loan scheme is available to private equity-backed companies. However, in the face of severe disruption, many sponsors will be taking exceptional measures to support portfolio companies. Here we outline some of the steps they are taking and could consider in order to strengthen their businesses.

Private equity firms have been quick to stress test portfolio companies for a sharp downturn. They are looking at loan covenants and other pressure points, such as forthcoming debt maturities, interest payment dates and revaluation events. Proactive steps include helping portfolio company CFOs to analyse and re-shape capital structures, and reaching out to lenders to proactively renegotiate terms.

In times of crisis, liquidity is critical. Companies are drawing down all available borrowing through revolving credit facilities, delayed-draw loans and other mechanisms, maximising balance sheet cash to buy as much operating time as possible. Many are also seeking to manage outflows by delaying or renegotiating rents and reducing overheads – for example tapping into government-backed schemes to furlough employees.

With deal professionals spending less time on potential new investments, private equity firms are using their skills elsewhere. Some sponsors are seconding senior team members to portfolio companies to work with boards on complex and pressing issues, such as reorganising supply chains impacted by the coronavirus outbreak.

Deal professionals act as a daily link between the sponsor and the portfolio company, speeding up action and response times, and bolstering the presence of sponsors’ existing in-house and external operations teams. As expected, those teams have gone into overdrive as they deal with extreme pressures at portfolio companies as a result of COVID-19.

Having stress-tested businesses and looked at operational support, private equity firms are then assessing the need for additional funding measures to support companies through the downturn. GPs are analysing the finances businesses are likely to need in coming weeks should lockdowns last longer, or economies not rebound as quickly as hoped. Among the measures currently being weighed are hybrid debt and equity financing packages.

Follow-on equity adds to a sponsor’s risk profile and presents the practical challenge of valuing businesses with a highly uncertain outlook. Emergency debt financing, on the other hand, is more senior in the capital structure but will not share in equity upside as portfolio companies come out of the crisis. Hybrid packages can offer the best of both worlds. They provide an attractive debt coupon – usually via a PIK (payment-in-kind) to avoid the pressure of additional interest repayments for the company – with equity exposure, either through conversion or a separate instrument, such as a warrant. These bespoke solutions can meet companies’ short-term funding needs at a lower risk to GPs and their investors.

Another mechanism sponsors can turn to – and which has precedent following the global financial crisis in 2008 – are debt buybacks or other purchases. When company debt is trading at discounted levels, portfolio companies or sponsors (through their funds) can buy up loans or bonds cheaply on the secondary market, if loan agreements permit. GPs can hold that debt to maturity as an additional source of returns, or it can be cancelled, thereby reducing leverage and increasing the equity ratio more cheaply than injecting fresh equity.

Debt buybacks, emergency financing and other responses do require careful consideration. Private equity firms will be revisiting fund documentation and loan agreements to understand what is permitted and where potential conflicts of interest might arise. Each option should be weighed carefully on its own merits. Nevertheless, exceptional times call for exceptional measures and sponsors are exploring all avenues to support their companies and protect their investors through the crisis.