Chima Ubani, John Groenewegen, Ed Vandenberg
Mar 23, 2020
Every business and industry will have to deal with the widespread impacts of the coronavirus pandemic (COVID-19). We expect that private equity and venture capital fund sponsors/managers/general partners (GPs) and investors will need to confront and navigate a number of issues in the coming months. To help guide GPs and investors, we have set out below some of the considerations that we believe will be most relevant as this situation evolves and in its aftermath.
Changes to existing fund documents
GPs may want to consider amending their existing fund documents or seeking consents or waivers from investors or advisory committees (where such flexibility is built into existing documents) to address the following issues, and investors will need to consider how they will respond to such requests.
- Commitment period extensions – GPs may be looking for an extension of the commitment period in anticipation of a slowing in the pace of new deal-making.
- Follow-on investments – It is likely that many portfolio companies will require more capital and at a different rate than initially forecasted by the fund. GPs should review their fund documents to determine whether limits regarding follow-ons, pacing or concentration will impact their ability to adapt their portfolio strategy.
- Recycling – GPs should review the provisions in their fund documents permitting the reinvestment (or “recycling”) of capital and consider whether to request an increase in their ability to recycle proceeds (both with respect to the timeframe and the amount) as one way of addressing increased capital needs.
- Borrowing – Funds may need to borrow more (through subscription lines and other forms of debt) during these times. GPs should review the limits on borrowing set out in their fund documents and consider whether they have sufficient capacity. Conversely, if borrowing capacity is or becomes unavailable, investors (who may be used to regularly scheduled capital calls, given the propensity of many funds to use capital call facilities to smooth the capital call process) should be prepared for more frequent requests for capital.
- Guarantees – Portfolio companies that need capital may also borrow more during these times and may look to funds for guarantees in respect of such borrowing. GPs should review the provisions in their fund documents that govern their ability to provide such guarantees.
- Changes to investment objectives and restrictions – Given the changing economic landscape, GPs may want to shift their investment objectives to address new opportunities. GPs should review the investment objectives and restrictions contained in their fund documents (e.g., geographic restrictions, limits on public market securities) and consider whether they are broad enough to allow the fund to make the types of investments that may become more attractive.
- Subsequent closing period – As market activity slows, it is likely that fund closings will take longer to achieve. GPs may want to extend the period of time during which the fund can admit new investors at subsequent closings. GPs and investors should also be prepared to consider whether the traditional true-up mechanism (based on the cost of investments) will be appropriate if the value of the portfolio has decreased substantially.
- Extension of the term – GPs may consider seeking an extension of the term of the fund to provide for more time to realize on investments. For funds near the end of their term, the extension may need to be longer than what is provided for in the existing fund documents.
Ongoing fund formations
GPs in the process of raising a fund will want to consider the issues highlighted above now and address them in their fund documents from the outset.
GP and investor relations
The importance of maintaining good investor relations will be magnified during these times. Below are some key points on which we believe GPs and investors should be focused:
- Regular communication – GPs and investors should communicate regularly with each other regarding the impact that COVID-19 is having on their respective businesses. For example, travel restrictions and the dramatic increase in the number of individuals working from home will likely slow down decision-making and approval processes, particularly in large institutions. GPs should anticipate this and ensure that they provide as much lead time as possible when making requests of their investors (e.g., for waivers or consents).
- Sharing of information – As investors try to understand the specific impact of this crisis on various industries and sectors, they will likely be seeking additional insight from GPs regarding the impacts being felt by underlying portfolio companies. GPs will need to consider how to effectively share these insights with investors, including by consulting with underlying portfolio companies.
- Reporting deadlines – Portfolio companies may be delayed in reporting to funds and GPs may therefore be delayed in reporting to investors. The ripple effect will extend to investors with their own internal reporting requirements. GPs and investors should be proactive in considering alternate forms of reporting and be transparent with their respective stakeholders.
- Side letters – GPs and investors should review their side letters and adjust their expectations with respect to matters such as meetings and extra reporting in light of the ongoing business interruption resulting from COVID-19.
For further information or support regarding the above considerations, please contact the authors of this Update or another member of our Private Equity or Venture Capital teams.