South Africa started 2020 on the ropes, with economists generally expecting the annual GDP growth to be below 1%. This already weak outlook has been exacerbated by the impact of the novel coronavirus (COVID-19) and the consequent curtailment of economic activity. COVID-19 is a game changer, with significant ramifications for every aspect of the global economy, and will bring challenges for the private equity industry.
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Fund managers need to be proactive and innovative in coming up with solutions to minimise the impact of COVID-19 on their own operations, as well as those of their investments. The COVID-19 pandemic will disrupt work processes in unprecedented ways.
Funds in the marketing cycle
The pandemic will be tough on fund managers in a capital-raising cycle. We are already seeing investors delaying or reducing commitments as they try to assess the impact of the economic fallout on their own balance sheets. Fund managers must be prepared to address these concerns, to redirect attention to the long-term nature of their investments, and to investment opportunities that will ultimately arise from the crisis.
Of course, fund managers will not be able to meet with prospective investors in person for the next few months, or traverse the conference circuit for new sources of capital. While it is not ideal to conduct these discussions without the usual social interaction, fund managers need to adapt quickly. It is an opportunity to leverage a captive audience (quite literally) and fund managers can stay in touch with prospective investors with interactive discussions and topics of interest. It may not be possible to get a firm commitment during the global lockdowns, but it is possible to impress prospective investors with insights and foresight, and to be ready to capitalise on opportunities as soon as the restrictions lift.
Where commitments are already in progress, much of the investor due diligence process can be addressed by making documents and information available in virtual data rooms and through video facilities, so that commitments can be advanced, subject only to the in-person due diligence being completed.
Fund managers should not lose sight of new potential opportunities. Impact investing has already started to play a bigger role in Africa as foreign development finance institutions dedicate more funding towards it, and commercial investors appreciate that the impact nature of the investments need not detract from profitability. According to the Africa Impact Report 2019, impact investing has, to date, been focused on energy and financial services. In the aftermath of COVID-19, however, we expect funding to increase in the healthcare, pharmaceutical, urban development and technology sectors.
Funds in the acquisition cycle
For fund managers in the investment cycle, there is a significant opportunity to capitalise on the market instability and lower valuations, for example, by acquiring listed companies that they may look to take private. Fund financing is likely to be attractive as interest rates are low.
While there are certainly operational challenges in relation to obtaining the required regulatory approvals, and to establishing the intermediate vehicles necessary to structure investments, this need not prevent deals being done, subject to conditions precedent. The negotiation, documentation and electronic due diligence of investments can and should continue to the extent possible. We expect substantial movement in pricing and terms, even as deals are being finalised, so fund managers should be alert and quick to respond.
Fund managers should ensure that their fund documents allow them to complete deals that are in-process after the end of their commitment periods and, depending on where they are in the cycle, should consider requesting a six-month (or longer) extension to the commitment period now, in order to alleviate pressure down the line.
They may also want to revisit their investment guidelines in order to hone in on opportunities arising in particular sectors or geographies, or to redirect their focus to sectors that are not as hard hit by the pandemic.
Funds in the value-add cycle
Fund managers need to take proactive steps to assist portfolio companies to survive the COVID-19 onslaught of lockdowns, suspended operations and upended markets. They should be assisting portfolio companies with developing and implementing contingency plans to address workforce considerations, identify and mitigate any potential supply chain disruptions, and ensure business continuity and financial stability.
Boards of portfolio companies should be reviewing force majeure terms of material contracts, reviewing insurance policies to assess potential recoveries for business disruption, managing liquidity and complying with ad-hoc obligations to notify lenders of possible adverse effects on their financial condition and/or business operations.
Funds nearing the end of their term may seek term extensions to provide portfolio investments with ample time to recover from short-term depreciation in value.
The implications of COVID-19 are changing with each passing week, and fund managers need to be nimble and seize opportunities as they present themselves. Those that are best prepared, and quickest to act decisively to protect the interests of their investors and portfolio companies, will be the ones that emerge strongest from this crisis.
Paige, Denenga and Nyatsumba are Partners in Webber Wentzel’s Private Equity Practice