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Law360 (April 20, 2020, 6:54 PM EDT) --
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| Barrie Covit |
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| Peter Vassilev |
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| David Wagner |
However, for the time being, we are continuing to see fund closings and investment activity as well as sponsors finding creative ways to adapt to the current market. We summarize below several primary issues that sponsors are facing as a result of COVID-19 and considerations for steps required to meet the direct and collateral consequences of these circumstances.
Fundraising
While we are seeing continued activity, particularly in the case of the largest sponsors, there are signs that the fundraising market is not itself immune to the virus. To the extent investors are engaged in the subscription process, we are generally seeing them follow through to closing.
But some investors are getting cold feet. Reasons for this development include substantive concerns about the market and the future, uncertainty over valuations, the denominator effect, volatility and simple administrative challenges. At least with respect to concerns about the future of the market, we are seeing in real time that investors are rewarding sponsors that have successfully stewarded capital through prior turbulence.
Social distancing initiatives worldwide are also giving rise to new fundraising challenges. For example, investor investment committees are finding it difficult to convene to approve fund investments, investor signatories are either unavailable or having trouble executing fund documents, and many notaries are closed and therefore not able to notarize required know-your-customer/anti-money laundering documents.
In light of these administrative challenges, we are seeing a an invigorated interest in electronic subscription documents as well as third party administrators, domiciliation agents and other service providers being more flexible with their onboarding procedures.
Investments and Portfolio Companies
The confluence of capital needs at portfolio companies and the freezing up of debt markets is daunting. The recent passage of the Coronavirus Aid, Relief and Economic Security, or CARES, Act — and in particular the Stabilization Act — together with the Federal Reserve's recent announcements of various liquidity programs, may provide a lifeline in certain cases.
For those sponsors who will need to inject additional capital into their portfolio companies, careful consideration of their contractual and fiduciary obligations is in order. Older funds that are out of their investment or follow-on periods pose special challenges, as do companies owned by more than one affiliated fund.
Where one such fund has available capital and authority to invest but another does not, questions of valuation come under the spotlight. Should the consent of either or both funds' advisory committees be obtained? Should the nonparticipating fund's investors be given the option to participate? Is there even time to undertake such a process?
These questions must be considered with counsel taking the specific facts of each situation into account.
For sponsors in their investment period with remaining dry powder or in their harvesting period with significant follow-on reserves, we are seeing a shift in focus to investment opportunities in public securities and debt instruments. In this regard, sponsors are revisiting their investment limitations in fund governing documents to determine their capabilities (i.e., restrictions on public market and debt investments).
Further, sponsors that identify debt opportunities in existing portfolio companies in which they are an equity holder are facing issues, including, among others, whether such investments can be made by the applicable equity fund, board level fiduciary issues — both in making the investment and on a go-forward basis — use of confidential information and tax considerations.
Disclosure and Reporting
Given the anticipated adverse impact that the current market volatility is expected to have on investment performance, sponsors are including specific disclosure regarding the impacts of COVID-19 in fund offering documents and Form ADVs. Although most fund disclosure documents already include disclosure regarding the risks associated with epidemics and pandemics, broadening these disclosures to capture the widespread impact of COVID-19 is advisable.
Moreover, sponsors with anticipated fund closings before first quarter valuations are available are providing appropriate preclosing disclosures regarding the impact that the current market environment has had and could have on both prior performance and investment valuations.
The continued volatility in public markets will ensure that the first quarter valuation exercise will not be a walk in the park and we expect cautionary language regarding valuations to remain a feature in legal disclosure for some time.
Operations
COVID-19 is also presenting fund sponsors with administrative and operational issues. For example, sponsors have been required to revisit their business continuity plans and employee policies, are asking their portfolio companies to do the same, and are adapting to remote working.
Sponsors are also reviewing their insurance policies to determine their level of coverage for potential claims resulting from disruption of business, travel and similar issues. COVID-19 has also disrupted annual investor meetings, with sponsors either cancelling investor meetings or hosting them entirely over webcast.
Conclusion
While the dislocation in global markets feels similar in many ways to the global financial crisis, the current uncertainty applies to almost all facets of life across the globe and sponsors of private funds have much to consider. That said, with public markets whipsawing, private equity may prove to be a rare place of comfort for investors.
Barrie Covit and Peter Vassilev are partners, and David Wagner is counsel at Simpson Thacher & Bartlett LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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