The intense economic uncertainty surrounding the coronavirus pandemic initially suffocated private equity investment and divestment activity. Certainly, managers are eyeing opportunistic dealflow, but spotting the bottom of a market artificially buoyed by unprecedented state support is tough. Meanwhile, exits of the caliber that will keep investors happy are likely to be few and far between until prices significantly rally.
As a result, it seems inevitable that GPs will be seeking fund term extensions, both to create cashflow breathing space, and to allow managers more time to deploy capital when the market eventually recalibrates. Equally, fund restructurings, which have already soared in popularity in recent years – shifting from the course of last resort to a legitimate portfolio management tool – are likely to proliferate still further.
“I think we will see an increase in demand for extensions. Clearly covid has caused delays to investment activity, primarily because it has been difficult to value companies during this period of extreme volatility,” says Patrick Bianchi, associate at Troutman Pepper.
“There has been no buying and selling for seven months and getting back to full speed will take a while,” adds Blinn Cirella CFO of Saw Mill Capital. “For example, we have one remaining investment in our first fund. We’ve extended the fund twice, as allowed by the LPA, and the final expiration date is 12/20/2020. We were five days away from taking that last portfolio company to market when covid hit and we will now not be able to sell before the end of the year. So, there will be funds that because of the ‘pause’, won’t be able to liquidate as intended.”
With LPs potentially facing a surge in approval requests, it is preferable that existing documentation provides for as many scenarios as possible.
However, over a quarter of respondents to this year’s Private Funds CFO Fees & Expenses Survey have no provisions pertaining to management fee impact in an extension period contained within their LPA. Of those that have failed to provide for this event, 18 percent presume that a reduction will be negotiated at the point of agreement. A further 10 percent, however, presume that fees will continue as normal.
“This was an issue when we conducted the survey in 2018 as well,” adds Tom Angell, practice leader at Withum’s Financial Services Group. “As much as attorneys try to get GPs to focus on these issues when drafting documents, there are clearly still those that resist.”
Of those managers that have addressed this issue in advance, meanwhile, half have allowed for fees to continue at the same rate, while 17 percent have agreed a reduction and 5 percent have agreed that the management fee can be eradicated altogether.
“In two years’ time, I would expect to see a decline in the proportion of respondents charging the same management fee during an extension period,” says Troutman Pepper partner Julia Corelli. “Since we usually act on the management side, however, we would resist that strenuously, arguing that the fee has already been reduced through a step down in rate, or the base on which it is being charged.”
Meanwhile, an overwhelming 78 percent have no provisions within their LPA regarding who will bear the costs of any restructuring – 40 percent have simply agreed that the decision will need LP approval at the time, while 38 percent have not referenced the scenario whatsoever.
“We do expect to see an increase in extensions and restructurings, and it is challenging when something isn’t written into policy,” says Neal Prunier, director of standards and best practices at Institutional Limited Partners Association. “Investors need to know exactly what they are getting into and so it is important to have strong, open dialogue between GPs and LPs on this matter.”