As governments and investors count the economic costs of the world’s new and deadly virus, populations globally have had to get used to a new way of life. We may not know yet how long lockdown measures and social distancing will need to be in place, but shocks such as the one we’re living through are often catalysts for change and can provide the spark for innovation.
Shifting entire firms from office bases to home working almost overnight and curtailing travel plans for the foreseeable future at a time of significant upheaval was, without doubt, a significant challenge for private equity funds, their investors and – for those that have not had to shutter entirely – their portfolio companies. While some measures will be short term, there could well be new practices and trends that endure long beyond the crisis, and not necessarily because these changes are forced upon the industry.
“This kind of event forces everyone to look at what they are doing and how they are doing it and to really re-evaluate,” says Brian Gildea, head of investments at Hamilton Lane.
The crisis has seen the industry dust off contingency plans that few believed they would need to use, especially at such scale – most will have planned for one or perhaps two offices to be shut down, with some functions moving to sites that were still operational. Yet today’s situation has involved the closure of every office for the majority of GPs and LPs. Despite this, for the most part, the move has been less painful than many might have predicted.
“The immediate impact has been a real-life testing of BCP [business continuity planning] for all concerned,” says Brian Lim, partner at Pantheon. “It seems to be working pretty well. People can work from home, AGMs have either been moved or have shifted to virtual meetings and it’s possible to access documents fairly readily because of the shift towards the cloud. I think people have been surprised in that they can do more than they might have imagined.”
Such profound changes, even short term, are bound to leave their mark and some believe that what we have seen will help the industry prepare for other threats that may be coming down the line. “LPs will focus more on disaster planning than previously,” says Kelly DePonte, managing director at placement advisory firm Probitas Partners. “This was always part of their due diligence, but it tended to be perfunctory.”
Tom Keck, partner at StepStone, echoes this point. “This kind of situation is likely to happen more frequently than previously and businesses in general are going to need to figure out ways of getting through disruptions,” he says. “The current crisis is creating better visibility around, for example, climate-related interruptions and the kinds of issues they might create.”
But beyond planning for disasters, might we see shifts in the way the industry operates? While it is too soon to predict with any certainty how private equity might be shaped, there are signs that certain features of the industry may change for good.
No one is suggesting that building face to face relationships with LPs is completely off the cards. After all, human contact is necessary to build one of the cornerstones of private equity investing: trust.
“If you are asking LPs to make illiquid, blind-pool investments that can span 10 years or more, they have to look into the whites of a GP’s eyes,” says DePonte. “Video links are not a substitute for in-person contact. When you visit an office, you pick up the culture and a feeling for how people in the organisation interact, so I don’t see technology replacing actual meetings over the long term.”
That said, the travel bans in place today are prompting some to question the hectic schedules many in the industry adhere to when it comes to fundraising.
Indeed, the current situation may hasten shifts that were already apparent. “Previously, we were seeing a trend in the industry of cutting executives’ flying time to reduce firms’ carbon footprint, so this may accelerate that trend,” explains Keck. “I’ve seen instances of LPs concentrating their travel, so they might take a lot of meetings in Asia, for example, in a short space of time. It’s a bit like speed dating – doing 20-25 meetings in a week. We could well see more of that.”
Living through lockdown has demonstrated what can be achieved remotely. Fundraising may well be down for 2020, but some firms have managed to continue their efforts, even under challenging circumstances – recent examples include Gilde Healthcare reaching $450 million for its fifth fund at the end of March, and Patrimonium announcing a €100 million first close in April. Tikehau Capital is also busy raising capital, says head of private equity Emmanuel Laillier.
“We have been able to continue doing business, even despite the significant disruption,” he says. “We are fundraising for some of our strategies, for example, and last week [in March], we were able to organise off-site due diligence with a US investor using video conferencing. It was very efficient and involved around 30 people from Tikehau, all working remotely and able to discuss risk, compliance, etc – it was a very complete, intense and detailed due diligence.
“I think that what today’s situation shows us is that, while we will still continue to need to meet people, it may not always be necessary. As an industry we may well discover that it can be very efficient to have some meetings using video – it saves on travel budgets, is a more efficient use of resources and it’s much better for the planet.”
While we continue to see some new investments being made, it seems unlikely that private equity firms will move to more digital means of assessing potential portfolio companies. “It’s very hard to do due diligence and develop business plans remotely – this will inevitably go back to face-to-face meetings,” says Gildea. “GPs need to meet management, walk the plant, see the assets, etc.”
However, some due diligence may become more reliant on technology – along the lines of the use of nano satellites to check the number of unsold cars in a car lot, for example.
Yet there may be some shifts in the portfolio management stage. The digitisation of company reporting is something that has been talked about for a long time, but remote working has underscored the need for greater standardisation of information and the ability to access records instantly.
“LPs will focus more on disaster planning than previously”
“What we’re seeing today may well accelerate the trend for getting paper out of the system,” says Ian Lynch, chief commercial officer at Intertrust. “We had to move from a situation where wet signatures were needed towards electronic signing in a matter of days, and I think we’ll see an acceleration of demand for more standardised operating models, administration and other systems. Where currently portfolio companies might send reports in different formats, such as PDFs and Excel, we’ll see standard datasets that can provide a single point of truth.”
Laillier agrees. “The current crisis is likely to accelerate the trend towards digitisation of company processes across the board, from HR and marketing through to compliance,” he says. “This should increase efficiency even without taking today’s situation into account.”
Board meetings could be another area for change. “Virtual boardrooms may become more prevalent,” says Lynch. “They won’t replace face-to-face interaction and you’ll still have meetings over dinner, but people are finding that video links work surprisingly well. You have to ask whether business travel will go back to the way it was before. I’m not convinced it will.”
Ongoing LP communications
In many ways, communication had already changed significantly following the financial crisis, but there may be more shifts to come. “The private equity industry has gone into this crisis in better shape than in previous downturns,” says Gildea.
“That said, it is quickly becoming obvious who has adequate resources and the capability to manage through this. The level of transparency, data and general communication is very different now from the past. LPs really want to understand their exposure and it’s definitely easier to get this, this time around.”
Yet new ways of communicating are becoming apparent as the crisis unfolds, as Laillier explains. “LP communication is always important, but is more vital than ever currently and so we are trying to keep our investors updated as quickly as possible,” he says. “We’ve been putting together weekly podcasts for our strategies, with some delivered to specific investors and others more freely available. It’s proving to be a good way of communicating.”
Environmental, social and governance issues were already rising up the agenda of LPs and GPs alike, but today’s situation may bring these factors into sharper focus when it comes to investing, particularly if attitudes more generally change over the course of the pandemic.
“At a broader level, we will see a societal and values shift as a result of this crisis,” predicts Laillier. “ESG issues were already important, but they will become much more so. Every day we hear stories about how cities are less polluted, for example, and people are discovering that a better world is possible. As governments help to restart economies, there will be pressure to do so through the development of low-carbon technologies and alternatives.”
And, given the heavy social cost of the spread of the virus and lockdowns, we may see more emphasis on this area in particular. “The S of ESG has often been the poorer cousin of the E and G,” says Lim. “However, there will be significant stress that comes from this crisis at a social level. I think this will concentrate minds at LP and GP level on areas such as workers’ rights and there may well be a shift more generally for businesses to have to be socially responsible if they are to remain viable. Indeed, the way businesses behave today towards employees and customers may well stick with people for some time to come.”
A potentially significant change could be that private equity has the opportunity to demonstrate its value to businesses and to the wider economy. There is no doubt the industry has suffered from a perception problem over the years, with politicians, the media and wider stakeholders often seeing private equity investment as a negative force. Yet the longer-term perspective offered by firms and the increased financial and operational support investment can bring, especially at times of crisis, has the potential to offer the industry a more positive counter-narrative.
“Private markets have an advantage in this type of situation,” says Gildea. “Not only is it possible to make quick decisions because of the more concentrated shareholder base, but there is also committed capital that can be deployed to support existing portfolio companies and invest in good opportunities once there is a little more clarity.”
Keck agrees. “When you have public markets moving 20 percentage points in one day, that kind of rollercoaster ride is difficult to manage,” he says. “Private markets don’t have that and provide investors with some stability. Private equity and private debt have a lot of flexibility to create solutions and so I would expect that the current crisis will show private markets in their best light.”