Switzerland | Private Equity and Deal-Making in Times of Coronavirus
This article will give private equity firms an overview of certain ToDos in this extraordinary time and should serve as a starting point for the work to be done over the next weeks, whether in relation to portfolio companies, the private equity firms themselves or ongoing (and future) transactions.
1. Portfolio companies
During the coronavirus pandemic private equity firms will have to carefully monitor their portfolio companies regarding certain topics, such as:
- Employees: Implementation of measures and policies required to ensure the health and safety of the employees, e.g. regarding remote working.
- Supply-Chain: Location of suppliers in areas affected by shut-downs, possibility to transport goods. Force majeure or similar clauses in supplier agreements.
- Customers: Is the company able to fulfil its obligations towards customers? Force majeure or similar clauses in customer agreements.
- Financial: Financial outlook of the company, including possibility for additional draw-downs under existing facility agreements or access to additional sources of capital (including governmentally sponsored programs). Check whether any financial covenants, reporting obligations or events of default in finance agreements are triggered, including possibility to cure/waive.
- Regulatory matters: Compliance with applicable governmental coronavirus-related guidelines.
- Long-term planning: What will the business look like after the coronavirus pandemic?
- Board members: Check whether special/additional duties (and potential liabilities) of board members apply.
- Corporate housekeeping: Comply with applicable corporate housekeeping requirements (shareholders’ meetings, etc.), with special attention to new rules applicable in various jurisdictions, e.g. on electronic participation.
2. Private Equity Firms
However, not only the portfolio companies will have to be carefully managed, there are certain topics (in addition to the ones mentioned above) directly affecting private equity firms and requiring their attention:
- Partnership agreements: Possible consequences resulting from lower investment values. Effects on fundraising, additional equity investments or delayed investments.
- Private placement memoranda: Risk factors sufficiently covering the current coronavirus pandemic.
- Communication: Pro-actively communicate with the limited partners.
3. Transactions in the Current Environment
Making deals in the current environment is subject to certain challenges, starting with organizational topics due to the limited availability of people working remotely. This will have to be considered not only for negotiations but also for signing/closing transactions, signing corporate documents that will often have to be filed as original, or also in the context of capital calls.
Transactions that are already signed but not yet closed should be checked for:
- MAC provisions: On the inclusion or carve-out of general market or economic conditions.
- Termination rights (and fees): Whether potential negative prospects give a termination right or what termination fees would amount to.
- Operating covenants: Targets might have to breach certain operating covenants (in particular regarding financing matters) in order to address liquidity issues.
- Representations and warranties: Potential breaches as well as the knowledge qualifiers (was the impact of the coronavirus pandemic known).
- Purchase price adjustments: For example, adjustment mechanism for lower normalized working capital or higher debt (cf. above).
- Ongoing transactions are likely to be delayed or cancelled. In our experience, cancellations were not only made due to the current uncertainty but also since there might be “better” opportunities available, i.e. targets with lower prices and higher returns on investment. In addition, exit transactions will become more challenging in the short-term and might have to be postponed if the expected return cannot be achieved.
In the short-term, also the private credit market is likely to take a hit which might be opportunity for traditional banks to step back in.
4. Transactions Post-Coronavirus
It is expected that the economy overall will recover, with uncertainties around the timing of such recovery. During the time of recovery, prices are also expected to fall compared to the pre-coronavirus phase. Since the record-level of dry powder will in principal still be available post-coronavirus, we expect the number of transactions to again reach pre-coronavirus levels. Finally, interest rates will likely remain at record-low level due to governmental efforts to stimulate the economy.
While “distance dealmaking”, i.e. transactions with little personal interaction, has been around since before the coronavirus pandemic, we believe that this trend will accelerate again. In particular, the technological tools in transactions (AI, software tools, electronic signatures, video- and phone-conferences) will be used more. The more general trend towards automatization with stronger reliance on technology and as little manpower as possible, is also expected to accelerate.
In transaction documents, we expect that pandemics, such as the coronavirus pandemic, will be specifically mentioned in W&I insurance coverage (likely to be excluded), MAC clauses (depending on the negotiation power), termination rights and the operating covenants. In purchase price adjustments, the effect of pandemics on the working capital will also have to be discussed (e.g. with floors to the adjustment mechanism).
Finally, during due diligence exercises, the insurance coverage of the target will have to be reviewed for any coverage during pandemics (business interruption insurance) and corresponding representations and warranties should be included.
Overall there are many aspects to be considered for private equity firms in this challenging time, be it with respect to their portfolio companies but also on the firms’ own behalf. Current transactions may run into delays but can in principle still be completed with the use of the technology available. We expect the private equity market to fully recover, given the still favorable market environment regarding interest rates, dry powder and potentially lower prices post-coronavirus.
Andreas HinsenLocal partner Attorney at law
Andreas Hinsen, attorney at law, is a local partner in our Zurich office. He focuses mainly on private equity, domestic and international M&A transactions, corporate governance, restructurings as well as general corporate and stock exchange laws.T: +41434346700 E: [email protected]