By Troy Pospisil, founder and CEO, InCloudCounsel – The Covid-19 pandemic has had massive economic impacts across the globe, though the ultimate effect on business remains to be seen. What will likely become clear in time, though, is that the pandemic will have a substantial negative impact on private markets that extends to almost every corner of the economy.
By Troy Pospisil, founder and CEO, InCloudCounsel – The Covid-19 pandemic has had massive economic impacts across the globe, though the ultimate effect on business remains to be seen. What will likely become clear in time, though, is that the pandemic will have a substantial negative impact on private markets that extends to almost every corner of the economy.
The global economic impact of the pandemic
At the outset, many expected industries on the front lines of person-to-person commerce, such as restaurants, hotels, and airlines, to bear the brunt of the pandemic. However, as time passes, we’re now seeing the consequences of the global shutdown reaching deeper into almost every industry.
Unexpected examples of economic downturn can be seen across all sectors. Surgery centres are seeing minimal business due to a notable drop in trauma cases and elective procedures. Cosmetic sales have dipped as hardly anyone is reporting to work or attending social events. Large amounts of commercial real estate debt are in technical default due to the inability of a massive number of tenants to pay rent.
Even SaaS companies, many of which generate a meaningful portion of their revenue from services, are starting to see an impact on existing revenue, in addition to a negative impact on enterprise sales pipelines. In all this upheaval, the private equity industry has not been spared.
Impacts on the PE industry
The Covid-19 pandemic has undeniably had negative effects on the private equity industry. The portfolios of private equity and private debt investors are feeling the impact due to their use of leverage in purchase and refinancing transactions. It’s worth noting, however, that PE-owned companies have historically outperformed during economic downturns.
PE firms that have long-term institutional relationships with their debt partners are going to have an easier time in the current pandemic than either smaller firms or firms that cherry-pick debt providers for each deal. Debt providers who aren’t worried about harming long-term relationships will be more tempted to aggressively enforce their rights under credit agreements in these difficult times.
Deal volume eventually will rebound, but not until companies can return to a normalised level of revenue. This will be necessary for companies to convincingly demonstrate that Covid-19’s impacts were short-term and allow them to obtain a valuation based on normalised EBITDA. Unfortunately, though, this return to normal likely won’t happen until at least Q4 2020.
The Covid-19 crisis might also leave LPs over-allocated to private equity if their public equity and credit portfolios remain depressed. Prior to the pandemic, most LPs were under-allocated to private equity and were looking to invest more into the asset class. The result of this potential overallocation will be a particularly difficult and competitive PE fundraising environment in the coming years.
Gaining an edge in Covid-19 times
As a highly competitive PE market adapts to the challenges of the pandemic, how can firms hope to gain an edge over the competition? First and foremost, firms should aim to align their internal teams around a uniquely differentiated investment strategy.
Successful private equity firms have achieved differentiated performance by pursuing niche areas like sector focus, corporate carve-outs, executive team building, proprietary sourcing, a willingness to take unique risks, and more. They should determine what set of strategies their team does uniquely better than others and focus on aligning their energy and resources around these.
Next, firms should identify the tactical activities that directly support their chosen strategy and have their teams focus 100 percent of their energy on those activities. All other activities should be candidates for outsourcing.
A simple way for firms to prioritise which tasks to outsource is to identify each activity that their teams spend time on and place them in a 2×2 matrix that measures its value in supporting their differentiated strategy against the time it consumes.
Most firms will quickly realise that their teams are spending far too much time on high-volume, repetitive legal work, such as NDAs, joinder agreements, release letters, and vendor contracts, that does not help to advance their unique strategies.
Thankfully, there is a large ecosystem of high-quality providers that can handle non-core tasks in a cost-effective manner and deliver a better solution than firms can likely build in-house.
Outsourced solutions designed to handle these non-core tasks are often superior to internally built solutions because vendors can invest more time and money in developing solutions that meet the demands of thousands of firms across the industry.
The leading outsourcing providers deliver unique benefits such as lower costs, higher quality work, scalable global solutions, and investments in technology to improve process efficiency and value.
By relying on these expert vendors to handle non-core tasks, PE firms can focus on the core business strategies that differentiate their firms from the competition. This focus is the key to gaining an edge in the highly competitive environment that will be reinforced by the Covid-19 pandemic.
