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21st July 2020
Thomas Doyle
Partner
In an opinion article written for Private Equity News, Thomas Doyle, Partner at 17Capital discusses how portfolio financing can help GPs and LPs manage liquidity and invest for further growth as firms address the short-term challenges posed by the pandemic and plan for the post-Covid-19 world.

Originally featured in Private Equity News

Portfolio financing is needed to get through the next two years

It is not why the holiday was invented, but the 4th of July this year marked a new kind of “independence” in the UK – an uncertain future coexistence with Covid-19. Pubs, restaurants and hairdressers were all permitted to follow retailers in throwing open their doors again.

This gradual opening up of the economy has been mirrored in many countries in recent weeks. However, the easing of restrictions has been marked by some notable regional setbacks, a sign of the expected non-linear recovery we will all have to accept until a suitable treatment is found.

For many businesses, the changes are a welcome relief after the strict rules preventing trading as normal during lockdown. And while we can all now start to see a slow return of everyday activities we previously took for granted, there has been a heavy price to pay. Unemployment is up and expected to rise much further as government support schemes fall away. According to the IMF, the global economy is set to shrink by 4.9% this year. It forecasts US GDP will fall 8% and the UK some 10%.

Liquidity demand

With such gloomy prospects, it is little surprise that the demand for liquidity from companies is still significant, as the key questions facing many of them remain – do they have enough cash to either ride out the ongoing crisis or, in some cases, to capture the opportunities that exist? And what happens if there is a widespread second spike of the virus, forcing many businesses into retreat once again?

The reality is that trading conditions for many businesses remain far from typical, and financial planning is a challenge. Companies have no idea whether pent-up demand will dissipate given the restrictions put in place to keep us safe; how long social distancing requirements will be needed; and what long-term changes to customer behaviour the Covid19 outbreak will cause.

Add to that the need for capital for ongoing investment and, potentially, for attractive acquisition opportunities that may well arise, as well as – at some point – delivering a return to shareholders, and the calculations can become rather foggy rather fast.
We think that companies should assume as a base case that they will have to operate under these more restrictive circumstances and with this level of uncertainty for up to two years, and plan backwards from there. Scientists suggest that two years is a realistic time frame to successfully develop a vaccine for Covid-19, given the amount of testing required, even on a fast-tracked basis, to ensure it is safe and effective. Treatment options, it is hoped, will be developed sooner.

Demand for liquidity from companies is still significant, as the key questions facing many of them remain – do they have enough cash to either ride out the ongoing crisis or, in some cases, to capture the opportunities that exist?”

For private equity fund managers, this means assessing every business in their portfolios and planning for both U-shaped and L-shaped recovery trajectories. While we all hope things will bounce back more sharply, a quick return to normality seems improbable. Managers therefore need to ensure that the companies under their stewardship have adequate resources to cope.
This is exactly what portfolio financing can provide. Through either highly flexible preferred equity instruments or NAV-based credit facilities, financing can be extended in return for exposure to the cashflows from a basket of underlying portfolio companies. The tailored nature of the products means that liquidity can be made available for whatever an investor in private equity requires, without the need to sell any assets or dilute ownership. Deals can be done quickly, and the exposure the lender gets to underlying cashflows means that there is full alignment of interests between all parties.

While relatively new, the use of portfolio financing has grown significantly, and the pandemic has only accelerated this trend. Many more GPs and LPs now recognise why it is an invaluable addition to their portfolio management toolbox, as they seek to help their portfolio companies weather the storm, capture strategic opportunities, or access the liquidity needed to return capital.

Quick and tailored

While there are obviously a number of ways that private equity investors can secure fresh capital, the current environment and the unique way that it is affecting many portfolio companies means it is more important than ever to be able to access financing that is both tailored to what is needed and can be provided quickly, with high transaction surety. This has been borne out by our experience – in the past few months alone, 17Capital has completed around $1bn worth of financings for private equity investors.

Many more GPs and LPs now recognise why it is an invaluable addition to their portfolio management toolbox, as they seek to help their portfolio companies weather the storm, capture strategic opportunities, or access the liquidity needed to return capital.”

It is vital that GPs and their portfolio companies address the short-term challenges they face and plan for the post-Covid-19 world, but portfolio financing is not just a defensive tool to be used in a crisis. It is also an invaluable tool for high-quality GPs and LPs to manage liquidity and investing for further growth and, like any tool, once successfully used it becomes something that can be deployed repeatedly.

Eventually, the current crisis will recede into the distance. And while its impact may ease, bringing relief for many people around the world, one thing that is likely to persist is a permanent shift in how GPs think about financing the companies for which they are responsible.