The new era of private equity
Alejandro Beltran de Miguel, Jeremiah Connolly, Alexander Edlich, Ari Oxman, Vivek Pandit, Laurens Seghers, and Elizabeth Skovira* *McKinsey & Company
Millions of health professionals are battling the disease, caused by the coronavirus (Sars-Cov-2), and putting their own lives at risk. Governments and industries around the world are working together to understand and address the challenge, support victims and their families and communities, and search for treatments and a vaccine.
The economic damages
Every business, large and small, is coming to grips with the unfolding crisis. Private equity (PE) firms and their portfolio companies come into the crisis riding a decade-long wave of growing transaction volumes, valuations, and fundraising. That position of strength may prove a bulwark in the months ahead, especially for firms that have exercised prudence recently. But there are also fault lines in private markets: deal leverage recently reached a new high, and multiples paid in recent months reached a multiyear high.
Ensure continuity of critical processes
PE firms need to keep crucial machinery running; they should continue to assess the investment pipeline, conduct investmentcommittee discussions, and manage all other essential processes through videoconferencing.
Similarly, they can continue regularly interacting with portfolio-company leaders through videoconferencing and shift to conducting board and review meetings virtually.
Firms might consider increasing the frequency of interactions, thus reducing lead time on agreed actions. This would allow maximum flexibility and agility for responding to fast-emerging challenges and making quick, risk-mitigating decisions (such as halting an exit).
Prioritize the portfolio
Sponsors are looking for clarity on the areas in which portfolio companies urgently need support and, when appropriate, course correction. Of course, the industry sector in which a portfolio company operates will be a strong determinant of how it will be affected. Some portfolio companies in healthcare or retail are part of the front-line response or provide critical products and services; ensuring that their supply chains are operating at peak performance is essential. Others (such as travel and hospitality companies) are experiencing immediate and unthinkable drops in consumer demand. Since most sponsors have limited resources to share with their owned companies (such as liquidity, operating executives to provide leadership and execution support, and critical relationships with other organizations), they will need to decide where best to
allocate time and resources.
A handy way to prioritize is to consider six indicators of disproportionate risk or impact. These aren’t exhaustive, and they may change as the crisis unfolds. But these are the six that sponsors are currently using successfully. These six dimensions can quickly identify portfolio companies that require more support. For example, some sponsors whose portfolio companies are dependent on international supply chains have rapidly identified a need to develop regional alternatives for critical parts to maintain operations.
Portfolio companies should move to assess operational risk rapidly and, when necessary, stabilize their operations. This will vary widely by sector. For example, many manufacturing companies are moving swiftly to create visibility into their supply chains, even in advance of potential issues, given the rapid shifts in customer demand. This can include analyzing available inventory (some is often hidden along the chain), comparing it with demand forecasts (which can be refined through direct customer communications and external market insights), and identifying alternative supply sources for critical parts. For example, some portfolio companies may look to source parts from vendors in regions with slower demand to supply more active factories. Manufacturers might also consider how to optimize production, distribution, and logistics. New production methods, vendors, and routes may be necessary to avoid supply disruptions. It’s also important to consider risks to critical counterparties, such as suppliers and customers.
Portfolio companies may need to work closely with and even support counterparties, especially smalland medium-size businesses, to maintain stability. Several public companies have been noteworthy leaders in this regard.