The COVID-19 pandemic has had an acute impact on the private equity deal environment and the broader global economy. In the midst of the disruption and initial partial recovery, Ropes & Gray attorneys have continued to advise our PE clients and their portfolio companies on navigating these turbulent waters and on a cross-section of the world’s most high-profile private equity transactions. In this update, we discuss key trends that our clients and contacts should consider and the transaction and portfolio company dynamics that we see on the horizon.
The developments described in this article include:
- During Q2 2020, there was a significant drop in sponsor-backed buyout activity across the globe, although the Asian markets and, to a lesser extent, the European markets, have recovered a bit faster than the U.S. market.
- There was a less substantial decline in PE fundraising activity on a total commitments basis. There appears to be an increased focus on larger funds and funds sponsored by established PE firms with known track records, as evidenced by the fact that significantly fewer funds have closed in Q2 2020 compared to Q2 2019 despite aggregate commitments not declining materially.
- U.S. PE portfolio companies have only begun to address the impact of COVID-19 with their lenders, with a flurry of activity around the end of Q1. A significant number of portfolio companies are likely to need longer-term solutions after the delivery of their Q2 or Q3 financials in the second half of 2020.
- U.S. buyout activity has been driven primarily by transactions involving businesses that are largely unimpacted (or in some cases are positively impacted) by COVID-19, or that have shown resilience despite these macroeconomic challenges.
- “Material Adverse Effect” definitions now typically include carve-outs for pandemics and accompanying orders, to the extent they do not disproportionately impact the target. Buyers have generally accepted those carve-outs and have focused instead on fact-specific disruptions at the target such as break-outs at facilities or unique supply chain disruption issues.
- Parties to transactions have continued to rely heavily on representation and warranty insurance, with premium rates and retentions remaining reasonably stable. The recent trend has been toward narrowly-tailored exclusions rather than broad exclusions from coverage for COVID-19-related matters.
- There continues to be a valuation disconnect between bullish public equity markets, on the one hand, and a global recession resulting from the impact of COVID-19, on the other hand.
- This valuation gap, along with the fact that financing for new transactions remains difficult, means that seller notes, earnouts, increased rollover and other similar mechanisms are increasingly being used to bridge the valuation and financing gaps. This trend may continue as the effects of the pandemic decline, and more businesses are marketed on the basis of COVID-adjusted EBITDA numbers.
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