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What exclusion from the CARES Act means for private equity

The exclusion of PE-backed businesses from the CARES Act is ‘disappointing’, but the industry hasn’t given up yet.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), signed into law on March 27, provides a $2.2 trillion stimulus package to help businesses and individuals soften the financial blow of covid-19. This includes the Paycheck Protection Program, which will offer federally guaranteed loans to small businesses below 500 people. Under the Small Business Administration’s ‘affiliation rules’, many private equity-backed companies will be disqualified from the scheme.

“It’s disappointing that a section of the US economy that is so important in terms of job creation was excluded,” said Tom Bohn, president and CEO at the Association for Corporate Growth.

The private equity industry has presented a united front in the push to extend the legislation to private equity-backed small businesses. Despite assurances that relief will be broadened to include some venture capital-backed companies and startups, there has yet to be significant movement on the PE side, and, at least for now, private equity portfolio companies will largely be ineligible for financial aid.

But Bohn and others are still encouraging PE firms and their portfolio companies for access to the CARES initiative, and many are hoping for an additional ruling on the act that will include PE-backed businesses. “There will be other chances to carve out opportunities for PE-backed companies – we’re still in the early days,” said Bohn.

Nonetheless, the pandemic will have its effect on private equity. “They [PE-backed companies] are incredibly durable but are subject to the same economics as the rest of the market, and with no money coming in, layoffs will happen,” Bohn added.

In a report from the National Center for the Middle Market, more than 80 percent of mid-market businesses surveyed had experienced some immediate negative impact from covid-19, with 25 percent believing that the pandemic would be “catastrophic” for business. Many fund managers have been said to be calling capital from LPs earlier than expected, and in larger amounts – sometimes in order to inject cash into their struggling portfolio companies. That also has implications for the industry at large, said Chris Hayes, senior policy counsel at the Institutional Limited Partners Association.

“Our first focus is really about making sure these companies can continue to operate and keep people on the payroll,” said Hayes. “Without access to these facilities, you run the risk of some of these companies closing or failing, or you could have capital calls to LPs for follow-on financing, who then may have to sell public market securities in a depressed market to meet those capital calls.”

Some in the industry have expressed concern that a rise in capital calls across the board could lead to LPs defaulting on commitments – either strategically or because of liquidity issues. But Jennifer Choi, ILPA’s managing director of industry affairs, explains that, while the organization has yet to see evidence of this becoming a larger trend, transparency between GPs and LPs about when to expect a capital call and where that capital will go remains crucial.

“LPs are looking at the extent to which GPs are focused more on the revolvers and the portfolio company level, which is independent of any dry powder that there might be, versus going to their LPs to seek rescue financing,” said Choi.

Equally, the prevalence of subscription credit lines could be an important lifeline to allow GPs additional flexibility and fast access to capital, said Choi, “and that wasn’t a feature in the financial crisis of 2009.”