*Authors of the article: Partner Isabel Rodríguez and associate Enrique Torné.
There is no doubt that it is, by any means, too soon to determine the socio-economic impact that the Covid-19 pandemic will have in Spain. Nevertheless, these last months of confinement and its de-escalation process have allowed us to begin to identify certain key issues.
Without thoroughly examining the impact of the pandemic in the different sectors of our economy and those of our surroundings, we can put forward that the Private Equity sector has suffered the consequences, although with clear nuances, of the complete and unprecedented standstill of the economic activity.
In particular, divestments from funds have been drastically reduced (the estimation lies around a 70% decrease globally), among others, in an effort to save the highly damaged rates of return as a consequence of the depreciation of the portfolio companies, and likewise, the fundraising has suffered a downward trend, waiting for the developments the market will experience in the coming months (notwithstanding the foregoing, the average of fundraising from Spanish private capital has increased a 36,4% compared with the same period last year based on open processes in 2019, ASCRI – Asociación Española de Capital, Crecimiento e Inversión says).
As a consequence of the above, management companies have been forced to look for a double path solution: firstly, in relation to the portfolio companies of the fund, for example by adjusting the corporate expenses or promoting the search for regional, national or European aids and; secondly, in relation to the fund itself, for example by extending the duration of the fund, extending the investment period, as well as, for those funds still in the fundraising stage but reaching the closing date, extending the fundraising period.
In this sense, the investor reaction will be forthcoming and, sooner than later, its acceptance of the measures tending to the amendment of the terms and conditions of the legal documents of the fund, as proposed by the management company, will have a direct effect on the management fee.
It is foreseen that the calculation of the management fee will be performed by an alternative method rather than the traditional one based in the number of the fund’s total commitments. Moreover, those investors that at the time being have a solid position and subscribe investment commitments in the first closings of the funds will benefit from significant discounts in the management fee.
All of the above will take place with the intention of attracting the investor and maintaining the dynamism of a sector that, not being exempt of the consequences of the pandemic, is a key sector for the economic reconstruction and the reactivation of the European business landscape, and more specifically the Spanish one.
There is no doubt that one of the biggest challenges of the Private Equity sector for the coming months will be aligning the interests of the management companies and the investors in order to favor fundraising, the maintenance of portfolio companies and an expected rate of return.
In this context, and in relation to keeping the portfolio companies afloat, the management companies will be in debate between exercising the “recycling” provisions, in order to provide liquidity to the portfolio companies in this moments of need, or using the different mechanisms the fund itself has that will allow it to finance itself via debt through various different means (this alternative would not be included in the total amount of commitments accounted for in relation to the calculation of the management fee).
In case the above fails to work, or does not have the expected success, the management companies will look for the necessary liquidity in the secondary markets, which once again, will rise as the main player for obtaining additional resources in a time of crisis (either to ease the liquidity distress that certain investors may suffer or to accommodate new investors in search for diversification alternatives). The management companies are already working in this possibility and, not to get ahead of ourselves, we are starting to notice some preliminary interests and certain activity related to secondary funds structuring in our market.
Without prejudice to the above, the Private Equity sector has an unprecedented amount of dry-powder, and therefore, especially for funds in the investment period, the current scenario offers interesting opportunities to include in the portfolio. Actually, it seems that the Spanish market remains steady in terms of the total number of investments, mostly in Venture Capital, though we are lacking the closing of “megadeals”. In any case, the issues of how to value these opportunities, taking into account how scarce they are and the their attractiveness for numerous management companies, the Due Diligence processes and the unwillingness of certain investors to short term drawdowns will be matters that will require the experience and a convincing performance from management companies.
That is, management companies that have proven, and are capable of continuing to prove in this circumstances, a high degree of resilience, professionalism and transparency with the investors will presumably earn a privileged position in the market, due to the fact that they will be the only ones prepared to diminish the expected increase in risk-aversion by a great number of investors.
In fact, a high concentration process of the Private Equity sector in the hands of bigger management companies is expected according to Coller Capital Global Private Equity barometer (in which is foreseen that this will be a trend in a 73% of the occasions).
There is no doubt that we live uncertain times, but there are plenty of reasons to believe that the Private Equity sector will be able to cope with the future socio-economic challenges that are arising in the horizon, specially taking into account that the European Union has understood that the reconstruction process must include the cooperation of public and private capital and, in this sense, is working in different proposals in which the Private Equity sector will be a key player.
Moreover, special attention also has to be payed to the exponential development of the ESG vehicles through the variety of measures that the European institutions have on their agenda with a clear target: lead the “green revolution”.