The pandemic’s impact on private equity firms and portfolio companies will only truly be known later this year, but managers have started to disclose, in broad strokes, the damage the virus downturn could wreak on their investments.
Firms have laid out risks resulting from the pandemic in mandated regulatory filings called Form ADVs that must be filed with the Securities & Exchange Commission by investment advisers with more than $150 million of assets. Most private equity firms were forced to register as investment advisers as part of the 2010 Dodd-Frank financial reform act, which put them under the regulatory purview of the SEC, including periodic audits and enhanced disclosures.
Form ADVs are updated each year, and many were refreshed as of the end of March. The recent disclosures include a section of risks that generally include a broad template of all the bad things that could happen to an investment, including natural disasters.
The forms reviewed by Buyouts include sections specifically citing covid-19, warning about potential impacts on employees, sourcing new investments, supply chain disruption, sector vulnerabilities and inability to properly manage existing investments.
GPs have to disclose in their Form ADVs current events that could have material impacts on their operations and investments, according to Marc Ponchione, partner at Debevoise & Plimpton.
Many GPs have made the determination that the pandemic has or could have a material impact on their operations and/or investments and added that to the updated Form ADV, according to Ponchione. “If it’s going to be a material effect, that’s something the adviser is having to disclose,” Ponchione said.
The broad disclosures in the Form ADVs would not be enough communication about the impacts of the pandemic with a manager’s limited partners, according to Vivek Pingili, director at ACA Compliance Group. GPs have been, and should be, in consistent communication with fund investors about status of existing investments, valuations and other impacts, he said.
“Your investors expect you to monitor those investments … you keep your investors abreast of all material developments of your business,” Pingili said. “Not just at the adviser level but if any portfolio companies are distressed, or they need additional financing, and what you’re doing about it. It’s a pretty detailed kind of thing.”
Supply chains, sick employees
Roark Capital, which has exposure to restaurants and consumer goods, said the coronavirus could have an impact on its ability to source supplies and on its franchisees.
“There are no comparable recent events in the US which provide guidance as to the effect of the spread of covid-19 and a potential pandemic on the business, financial condition and results of operations of the funds and their portfolio companies,” Roark said in its updated Form ADV filed in March.
“Therefore, there is substantial uncertainty of covid-19’s potential effect on the funds and their portfolio companies, which could have a material adverse effect on the funds’ investments and on the business, financial condition and results of operations of the Funds’ portfolio companies,” the Form ADV said.
Many of the disclosures appear to be templates guided by GPs’ law firms, which made the determination that the impacts of the pandemic are material enough to be included in the annual update.
“Covid-19 and corresponding containment efforts have impaired and will continue to impair, potentially for an extended period of time, our ability to monitor and manage existing fund portfolio investments as well as source new investments to execute the fund’s investment strategies,” TPG said in its latest disclosure. “Given the extraordinary nature of covid-19 and its inherent unpredictability, it may take years to understand the full scope of its ramifications.”
The disclosures also touch on risks to GP and portfolio company personnel. Significant illness could hinder firm employees’ abilities to do their job.
“The spread of covid-19 among L Catterton’s personnel and its service providers would also significantly affect the [firm’s] ability to properly oversee the affairs of the funds (particularly to the extent such impacted personnel include key investment professionals or other members of senior management), which could result in a temporary or permanent suspension of a Fund’s investment activities or operations,” according to L Catterton’s Form ADV.
Also, the pandemic could turn firm employees’ attention from their day jobs, according to a Form ADV filed in March by Hellman & Friedman.
“As global market and economic disruptions continue, H&F and portfolio company personnel will be pulled from the day-to-day operations of H&F, the funds and portfolio companies into managing the response to the impact of such disruptions,” the disclosure said.
“In order to address such daily crises and disruptions, H&F personnel will not be able to devote the same level of attention to all portfolio companies as they did before the covid-19 outbreak, as they will focus on portfolio companies impacted the most by the covid-19 outbreak, and the amount of time available for H&F personnel to seek new investment opportunities on behalf of the funds will be materially diminished,” the disclosure said.
Other firms that have included covid-19 details in their updated Form ADV reviewed by Buyouts include Madison Dearborn, Marlin Equity and Vista Equity. Vista warned that governmental emergency efforts could impair existing legal and financial structures that make it harder for the funds to fulfill their investment objectives.
“They may also impair the ability of funds’ investments or their counterparties to perform their respective obligations under debt instruments and other commercial agreements (including their ability to pay obligations as they become due), potentially leading to defaults with uncertain consequences, including the potential for defaults by borrowers under debt instruments held by a fund,” the ADV said.
Action Item: Check out L Catterton’s Form ADV here: https://bit.ly/2L52mf6