Originally featured in The Drawdown.
Out of deep freeze and into the sun – how are private equity firms financing COVID-impacted companies?
As the world opens back up, thanks to a successful Covid vaccination drive, many private equity-backed companies are similarly emerging from enforced hibernation. As they re-engage, many businesses will want fresh capital, whether to go on the offensive, making the most of opportunities thrown up by the crisis, or for defensive needs, to see them through the final stages of the pandemic. In both cases, new sources of strategic financing are emerging to help fulfil these funding needs.
While many companies have thrived or survived, whether by offering goods and services that have remained in demand, or through government support and understanding and flexible lenders, that is not a universal picture. Even where businesses have got through the crisis more or less unscathed, their owners’ exit plans are likely to have been delayed.
Sectors impacted by the pandemic
But most private equity funds have at least one asset in sectors that have been particularly impacted by the pandemic, such as leisure, entertainment and travel. Now that conditions are clearing and GPs are again more focused on new investment opportunities, the question now is what to do with those businesses and what capital is going to be required to meet these new goals.
Some businesses will want capital to capture compelling opportunities to invest in mergers and acquisitions, for example to consolidate markets where valuations have been impacted by the pandemic. Others will require further financial support simply to keep going, as state funding schemes are withdrawn, and lenders take a more hard-line stance on covenant breaches or providing waivers.
Experience and knowledge
Private equity firms are generally well positioned to help portfolio companies coming out of suspended animation, no doubt helped in part by the experience of surviving the last economic catastrophe, the global financial crisis that began in 2007. The best-in-class GPs have accumulated the market knowledge and the M&A experience to tackle these scenarios. They have the know-how to help stabilise assets that otherwise are at risk of restructuring and to capture transformational opportunities once sector specific COVID effects subside.
Where it becomes more challenging for them is in finding the right sources of capital to meet either of these goals.
Traditional debt funding may not be an option because bank loans may well have been fully extended, while many institutions are understandably reluctant to back ambitious growth plans while the global recovery is still in its tentative stages.
While equity financing is an option – as long as funds are not fully-called and concentration limits are not breached – this can be expensive. The cost of equity capital looks particularly high given financing is probably only needed for between six months and two years. After that, the equity sponsor is likely to sell the business outright or refinance it following a sustained period of positive post-pandemic trading.
Single-asset portfolio financing
One solution that is increasingly gaining popularity among top-flight private equity firms is single-asset portfolio financing, something 17Capital has been offering since 2018. These transactions involve the provision of capital via highly flexible preferred equity. Each financing deal is bespoke to the borrower’s specific circumstances, with funding extended in return for exposure to the cashflows from a diversified basket of the private equity firm’s other portfolio companies.
The new capital is taken by the portfolio company as equity, delivering an attractive cost of capital, as well as giving the private equity sponsor advantages in its relationship with the company’s existing lenders. This type of funding is fully bespoke in nature and flexible – preferred equity has no fund support or fixed repayment dates. Despite this flexibility, such investments can be structured at a highly competitive price point if the private equity fund in question provides uncalled capital support.
Given all this, it is not too difficult to see why single asset portfolio finance is coming of age. As the portfolio companies that stand to benefit the most from this form of finance come out of hibernation and feel the sun on their backs for the first time in many months, they are also demonstrating that it is equally a bright new day for finance providers willing to use their imagination and deliver much-needed innovation.
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