COVID-19 and the private equity industry

Practical steps for responding to the coronavirus crisis

The coronavirus (COVID-19) outbreak is causing widespread concern and economic hardship for consumers, businesses and communities across the globe. The situation is changing quickly, with widespread impacts. We’ve prepared some general guidance on COVID-19: What US business leaders should know: crisis management and response, workforce, operations and supply chain, finance and liquidity, tax and trade, and strategy and brand.

Most companies already have business continuity plans, but those may not fully address the fast-moving and unknown variables of an outbreak like COVID-19. Typical contingency plans ensure operational effectiveness following events like natural disasters, cyber incidents and power outages, among other crises. They don’t generally take into account the widespread quarantines, business and community disruptions, extended school closures, and added travel restrictions that may occur in the case of a health emergency.

The crisis raises a number of unique challenges. In PwC’s inaugural COVID-19 CFO Pulse Survey, finance leaders in the United States and Mexico shared their top concerns.

Issues that private equity firms might face:

As PE firms’ ownership of underlying companies isn’t designed to be long term, these companies may have less robust contingency plans for dealing with this type of emergency. Additionally, scenario planning conducted by PE firms upon acquisition doesn’t typically cover this type of situation. 

PE firms may be facing a situation in which they have multiple underlying companies with hundreds or thousands of employees looking for guidance and direction during this crisis.

While cybersecurity is always a top priority for PE firms and their portfolio companies, they may face additional threats and vulnerabilities now. This is because they will have significantly higher levels of remote access to core systems, along with employees and management who could be more susceptible to social engineering efforts in the midst of a crisis.

Steps to consider:

• Establish a common crisis response structure for portfolio companies — one with clear responsibilities and direct accountability.
• Map critical stakeholders and develop a communication plan for each stakeholder group to maintain trust and reputation. Focus on cascading quality communications to portfolio companies. 
• Identify and maintain crucial decision points to manage and contain exposure to the virus (such as restricting travel) based on an agreed-upon set of data sources.
• Update scenario plans and agree on actions to cover a 3-6 month impact and a 12-18 month impact, as well as a process to update these plans weekly. Review items such as insurance coverage, creditworthiness of providers, key-man risk, systems capabilities for the off-site workforce, and cyber readiness.
• Conduct a phishing exercise now to reveal gaps in your defenses.
• Strengthen your network’s perimeter, using security tools to identify and deflect threats before bad actors can intrude.
• Fortify your endpoint protection, and make sure devices and software are hardened and patched.

Issues that private equity firms might face:

Portfolio companies often don’t have the HR expertise and infrastructure required to manage during a crisis, so they may seek guidance from their PE sponsors to help them effectively address workforce issues. PE firms should leverage their resources to provide necessary guidance to their portfolio at scale.

Due to the different needs, strategies and capabilities of each underlying company, PE firms have to wrangle a diverse host of workforce issues. Office-based businesses may seek guidance on work-from-home provisions, whereas manufacturing facilities face different safety and continuity considerations. Geographic diversity and local government regulations also come into play.

Without the right monitoring and planning, PE firms could be overloaded with issue after issue, causing a fire drill every time. Additionally, HR policies and directives may be inconsistent within and across the underlying entities.

Steps to consider:

• Offer cross-portfolio information resources, webinars, and/or virtual trainings for CHROs and key leaders on critical topics, including: 
  • HR policies that align with local regulations (such as entitlement to continued pay during quarantine, covering costs of medical tests)
  • Work site risk mitigation programs and guidance options
  • Labor cost take-out strategies that preserve long-run continuity.
• Gather necessary data on employees (such as geography and visas), track movements during crisis, and set up quarantine and testing policies for access to work sites, where applicable.
• Invest in workforce mobility solutions to enable remote working across portfolio companies, where applicable. Provide training and support as employees transition to the new ways of working.

Issues that private equity firms might face:

Upon acquiring a company, many PE firms focus quickly on making changes to indirect spend (such as office supplies, travel, shipping), and they entrust the underlying company to handle direct spend (materials needed to make revenue-generating products). 

Further, if the underlying company is in a specialized industry (for example, biotech), expertise in sourcing vendors that are not affected by the virus may take time and effort that it cannot afford. Indeed, it’s possible that a third-party provider may prove to be a critical point of failure in creating a response to COVID-19.

Steps to consider:

• Perform an operational risk assessment internally and with key suppliers and partners to discuss disruption of critical business functions.
• Implement a plan to gain visibility into the supply, capacity and data needed to adapt.
• Create strategies for strategic sourcing, including alternative vendors and any tariff and lead-time impacts.
• Extend communication plan with key suppliers and customers on capacity, liquidity, legal obligations.
• Set and maintain policies for authorized extraordinary spending to secure supply.
• Collaborate with sales on how to allocate scarce supply and/or capacity, as well as the potential to sell any excess inventory.

Issues that private equity firms might face:

The crisis may not hit every geography equally. In areas that have been particularly hard hit, PE firms could be trying to adapt quickly to new rules and deadlines. In other areas, they may still need to comply with traditional filing and compliance deadlines.

PE firms should also evaluate how an impact to operations of the portfolio company (from reduction in normal operations, business interruption or non-recurring expenses) may be treated from an indenture perspective in their lending agreements. Depending on the potential add-back, they may need to track and monitor those costs and losses.

Steps to consider:

• Continue to monitor all applicable regulatory environments and keep on top of compliance and filing deadlines.
• Review legal covenants for responsibilities relating to borrowings, managed inventory positions, returned stock and more. Proactively prepare notices where needed.
• Review debt indentures and discuss with lenders how to treat operating losses and expenses.
• Consider bolstering forecasting capabilities.

Issues that private equity firms might face:

There are a host of hidden tax issues that can affect a company’s decision-making process during this crisis. For example, choosing the wrong backup vendor could expose a firm to an unplanned tax burden because of vendor location changes or other reasons.

Steps to consider:

• Discuss with tax teams how extraordinary expenses (direct material costs separate from operating and capital expenses) should be handled. Consider whether any losses will generate tax attributes that may be used in the future.
• Track and analyze imbalances of revenue and costs as supply shifts.
• Use staff movement tracking to determine if employees’ primary tax locations have been affected.
• With travel restrictions, consider if changing key decision-making locations will affect taxable presence.
• Continue to track all tax jurisdictions for any tax incentives or stimuli that could benefit or impact the underlying company. If you cannot meet factors necessary for certain incentives, consider seeking relaxation.
• Evaluate debt covenants and the impact of refinancing options.
• When using a hedging instrument, remember that there may tax implications from foreign exchange (FX) gains or losses.
• Consider your ability to meet tax filing and reporting deadlines.

Issues that private equity firms might face:

This crisis is demonstrating to PE firms the importance of improving risk strategy. Some firms are even thinking ahead to what tools and technologies they can use to help anticipate this type of risk in the future.

Given the level of debt present on most portfolio companies' balance sheets, some firms may face increased liquidity risks and unanticipated challenges with their ability to make interest payments and avoid defaults. Portfolio companies may also encounter cash-flow problems should customers be unable to pay.

Steps to consider:

• In the coming weeks, keep track of issues in which an automation solution would help speed decisions. Revisit these after the situation becomes more stable.
• Improve risk assessments for hot spots and vulnerabilities in sources of supply and production before shifting sales strategy or introducing new products to the market.
• Update detailed cash-flow forecasting (including potential asset impairments and covenant compliance) over the coming months as part of your risk assessments. Consider bolstering forecasting capabilities.

Issues that private equity firms might face:

In the weeks since the COVID-19 outbreak, customer behavior has drastically changed, regardless of whether you are B2B or B2C. Consumers are staying at home and have shifted their consumption habits toward those products needed to survive the crisis. Additionally, companies have had to ramp down production and slow their purchases. 

For PE firms, this means a drastic shift in ongoing business strategy. Companies that cannot adapt could be struck with the kind of disruption that dampens business or, in the worst case, ends a company’s prospects for survival.

Steps to consider:

• Revise your sales strategy to adjust to evolving customer behaviors and the competitive environment.
• Focus strategy on protecting customer relationships and commercial instruments.
• Model customer behavior changes in actions made by the underlying portfolio company.
• Innovate and invest in dominant sales channels (e.g., online vs. in store).

Issues that private equity firms might face:

Generally speaking, private equity firms do not allow redemptions, thereby avoiding the investor issues that affect other fund classes. However, investors can demand full transparency when it comes to a PE firm’s actions in this crisis. 

In dealing with COVID-19 issues, PE firms could lose sight of basic investment company issues, such as commitment call deadlines, financial statement filings and shareholder updates.

Steps to consider:

• Include internal firm employees in communication plans and workforce assessments.
• Where possible, institute workforce mobility programs.
• Evaluate liquidity needs and debt covenants to ensure continuing operations (if markets continue to be disrupted).
• Establish consistent updates with investors, adapting to new requests for information.
• Examine partnership agreements to ensure all necessary deadlines are met or extensions are requested from investors.
• Review valuation models for impairment of any assets affected by the crisis.