Private Equity Update
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Private Equity Update A year and more on from the UK’s first lockdown, business continues to adapt to the impact of the COVID-19 pandemic. Whilst the early stages of the pandemic saw private equity investors focus on stabilising their portfolios, investors adapted quickly and the second half of 2020 saw a resurgence in activity as many deals previously placed on hold were completed. As we move into the second half of 2021 this update reviews briefly the prospects and challenges for the sector. Johnathan Rees Partner | Head of Corporate & Commercial johnathan.rees@laytons.com +44 (0)20 7842 8000
Private Equity Update
Opportunities
Challenges
With a vast amount of uninvested capital at investors' disposal there a number of opportunities for PE backed deals.
As the impact of the pandemic plays out some of the more immediate issues confronting private equity include:
• Portfolio bolt-ons
PE will continue to encourage and finance growth
• Virtual world
Private equity firms and their advisers adapted quickly
by acquisition among their portfolio companies -
to the challenges posed by the shift to the online
particularly having completed any necessary repairs
world successfully navigating remote presentations,
and identified those companies best-placed to grow.
management meetings, due diligence and deal execution. While some innovations may become
• Disruption
permanent and have helped investors improve the
Private equity is renowned for its ability to prosper
efficiency of their processes, elements of due diligence
during economic disruption. The on-going business
and portfolio management inevitably benefit from
turbulence caused by the crisis represents an obvious
old-style face-to-face meetings.
investment opportunity - particularly as government support is withdrawn in the second half of the year.
• Hybrid working
Businesses continue to adapt working practices to the
• Carve-outs
changes brought about by the various lockdowns.
As public companies and large private groups review
Portfolio companies will have an opportunity both to
their structures and redirect resource to their core
downsize and save costs while simultaneously being
businesses, transaction opportunities will arise whether
able to offer staff flexible working arrangements.
in form of carve-outs or public-to-private sales both
Effective consultation together with finding the
of which private equity is well-placed to execute and
optimum balance between individuals’ preferences
support.
and the organisation’s needs, technological constraints and effective supervision will be key. Monitoring the
• Demand
Pent-up demand and robust credit markets should
well-being of employees working remotely is also essential.
mean a plethora of opportunities for private equity in the coming months.
• Future proofing
Whilst investors will have spent a large part of their time during the pandemic working with their portfolio companies, the need to improve businesses’ resilience to future economic shocks is an evolving theme and will continue to require the time and attention of management and investors. All this being said, inevitably some changes and innovations to business practices and models will prove to be less useful and
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Private Equity Update
not survive long-term. Businesses will benefit from identifying those sooner rather than later. • Prudence
Private equity investors will need to be discerning given the likely surge in transaction opportunities with a premium on sector expertise and sound due diligence.
• deferring bonus payments coupled with shareholder loans to finance bridging funds to management • cash retention incentives. Whilst the investor’s attitude to the dilutive impact of any changes will of course be key, the tax implications – particularly where EMI or CSOPs are involved – will need careful scrutiny to ensure that the tax status of those arrangements is not jeopardised. It is vital to all stakeholders that management have a clear understanding of the return
Management incentives
expected by the investor and at what point management equity becomes valuable.
A significant consequence of the pandemic for PE backed companies is the impact of the economic turmoil on management incentive arrangements e.g.: • performance conditions and targets – set in very different times – have become unrealistic strike prices of options may be higher than market value • exits may have been pushed back The consequence is that management may have become disincentivized or incentivized to make business decisions
IR35 The government recently introduced new IR35 legislation changes. Amongst other things these rules mean that certain businesses which previously engaged workers via an intermediary (e.g. a personal service company) will now need to check whether those workers are disguised employees or office holders. These new rules may have significant implications for PE investors who typically engage
not necessarily consistent with strategy – or both.
with a large number of consultants and contractors – from
It also creates a challenge for the investor to recruit.
sitting on PE advisory boards. There are potentially
Solutions are various and broadly fall between refining
consequences of these changes may impact the proceeds
existing arrangements and implementing new versions. Examples include:
appointees to portfolio boards to industry specialists significant implications for the portfolio companies too. The of a future exit and will force PE investors to look closely at their arrangements.
• restructuring of investor debt or ratchets • exit cash bonuses • modifications of performance conditions e.g. reset of hurdles or adjusting profit calculations or targets • adjusting strike prices to reflect the impact on performance of the pandemic • new ordinary share issues whose value is linked to the performance of specific parts of the business
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Private Equity Update
Investment Trends • Businesses whose models which were immune to
Closing thoughts These are interesting times for private equity. Whilst the
the worst effects of the pandemic will inevitably
economic outlook has improved significantly it remains
attract attention. Alternatively, those sectors which
difficult to predict. There are likely to be significant
were harder-hit such as retail and leisure are likely to
opportunities for PE backed transactions in the short term
present opportunities of a different sort for investors
and so too for incumbent management teams.
experienced in turning around distressed assets. We have significant experience of advising management • Similarly, businesses with models which are perceived
teams of PE backed companies at various stages of the
as resilient to, or anticipated to benefit from, the
investment lifecycle and of working with investors and
socioeconomic changes being wrought by the
management teams to devise solutions to restructure
pandemic will be a target for investment.
management incentive schemes. If you would like to discuss any of the above we have specialists who can help.
• The broader technology sectors – from financial services to gaming software - have been the focus of attention for several years before COVID-19 and that trend is likely to accelerate. • Environmental social and corporate governance (ESG) continues to play a significant part in the investment strategies of many private equity investors. Leaving aside the connection between ESG investing and financial returns, there is little question that ESG has become essential to not merely fundraising but also engaging potential investees.
Please contact Johnathan Rees, Head of our Corporate & Commercial Team to arrange a conversation.
Key contacts Johnathan Rees Partner johnathan.rees@laytons.com +44 (0)20 7842 8009
John Gavan Partner john.gavan@laytons.com +44 (0)20 7842 8000
Cameron Sunter Partner cameron.sunter@laytons.com +44 (0)20 7842 8036
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This information is offered on the basis that it is a general guide only and not a substitute for legal advice. We cannot accept any responsibility for any liabilities of any kind incurred in reliance on this information.
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