Private Equity Update

Private Equity Update

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Private Equity Update A year and more on from the UK’s first lockdown, business continues to adapt to the impact of the COVID-19 pandemic.

Whilst the early stages of the pandemic saw private equity investors focus on stabilising their portfolios, investors adapted quickly and the second half of 2020 saw a resurgence in activity as many deals previously placed on hold were completed.

As we move into the second half of 2021 this update reviews briefly the prospects and challenges for the sector.

Johnathan Rees Partner | Head of Corporate & Commercial johnathan.rees@laytons.com +44 (0)20 7842 8000

Private Equity Update

Opportunities

Challenges

With a vast amount of uninvested capital at investors' disposal there a number of opportunities for PE backed deals.

As the impact of the pandemic plays out some of the more immediate issues confronting private equity include:

• Portfolio bolt-ons

PE will continue to encourage and finance growth

• Virtual world

Private equity firms and their advisers adapted quickly

by acquisition among their portfolio companies -

to the challenges posed by the shift to the online

particularly having completed any necessary repairs

world successfully navigating remote presentations,

and identified those companies best-placed to grow.

management meetings, due diligence and deal execution. While some innovations may become

• Disruption

permanent and have helped investors improve the

Private equity is renowned for its ability to prosper

efficiency of their processes, elements of due diligence

during economic disruption. The on-going business

and portfolio management inevitably benefit from

turbulence caused by the crisis represents an obvious

old-style face-to-face meetings.

investment opportunity - particularly as government support is withdrawn in the second half of the year.

• Hybrid working

Businesses continue to adapt working practices to the

• Carve-outs

changes brought about by the various lockdowns.

As public companies and large private groups review

Portfolio companies will have an opportunity both to

their structures and redirect resource to their core

downsize and save costs while simultaneously being

businesses, transaction opportunities will arise whether

able to offer staff flexible working arrangements.

in form of carve-outs or public-to-private sales both

Effective consultation together with finding the

of which private equity is well-placed to execute and

optimum balance between individuals’ preferences

support.

and the organisation’s needs, technological constraints and effective supervision will be key. Monitoring the

• Demand

Pent-up demand and robust credit markets should

well-being of employees working remotely is also essential.

mean a plethora of opportunities for private equity in the coming months.

• Future proofing

Whilst investors will have spent a large part of their time during the pandemic working with their portfolio companies, the need to improve businesses’ resilience to future economic shocks is an evolving theme and will continue to require the time and attention of management and investors. All this being said, inevitably some changes and innovations to business practices and models will prove to be less useful and

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Private Equity Update

not survive long-term. Businesses will benefit from identifying those sooner rather than later.

• Prudence

Private equity investors will need to be discerning given the likely surge in transaction opportunities with a premium on sector expertise and sound due diligence.

• deferring bonus payments coupled with shareholder loans to finance bridging funds to management • cash retention incentives.

Whilst the investor’s attitude to the dilutive impact of any changes will of course be key, the tax implications – particularly where EMI or CSOPs are involved – will need careful scrutiny to ensure that the tax status of those arrangements is not jeopardised. It is vital to all stakeholders that management have a clear understanding of the return

Management incentives

expected by the investor and at what point management equity becomes valuable.

A significant consequence of the pandemic for PE backed companies is the impact of the economic turmoil on management incentive arrangements e.g.: • performance conditions and targets – set in very different times – have become unrealistic strike prices of options may be higher than market value • exits may have been pushed back The consequence is that management may have become disincentivized or incentivized to make business decisions

IR35 The government recently introduced new IR35 legislation changes. Amongst other things these rules mean that certain businesses which previously engaged workers via an intermediary (e.g. a personal service company) will now need to check whether those workers are disguised employees or office holders. These new rules may have significant implications for PE investors who typically engage

not necessarily consistent with strategy – or both.

with a large number of consultants and contractors – from

It also creates a challenge for the investor to recruit.

sitting on PE advisory boards. There are potentially

Solutions are various and broadly fall between refining

consequences of these changes may impact the proceeds

existing arrangements and implementing new versions.

Examples include:

appointees to portfolio boards to industry specialists significant implications for the portfolio companies too. The of a future exit and will force PE investors to look closely at their arrangements.

• restructuring of investor debt or ratchets • exit cash bonuses • modifications of performance conditions e.g. reset of hurdles or adjusting profit calculations or targets • adjusting strike prices to reflect the impact on performance of the pandemic • new ordinary share issues whose value is linked to the performance of specific parts of the business

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Private Equity Update

Investment Trends • Businesses whose models which were immune to

Closing thoughts These are interesting times for private equity. Whilst the

the worst effects of the pandemic will inevitably

economic outlook has improved significantly it remains

attract attention. Alternatively, those sectors which

difficult to predict. There are likely to be significant

were harder-hit such as retail and leisure are likely to

opportunities for PE backed transactions in the short term

present opportunities of a different sort for investors

and so too for incumbent management teams.

experienced in turning around distressed assets.

We have significant experience of advising management • Similarly, businesses with models which are perceived

teams of PE backed companies at various stages of the

as resilient to, or anticipated to benefit from, the

investment lifecycle and of working with investors and

socioeconomic changes being wrought by the

management teams to devise solutions to restructure

pandemic will be a target for investment.

management incentive schemes. If you would like to discuss any of the above we have specialists who can help.

• The broader technology sectors – from financial services to gaming software - have been the focus of attention for several years before COVID-19 and that trend is likely to accelerate.

• Environmental social and corporate governance (ESG) continues to play a significant part in the investment strategies of many private equity investors. Leaving aside the connection between ESG investing and financial returns, there is little question that ESG has become essential to not merely fundraising but also engaging potential investees.

Please contact Johnathan Rees, Head of our Corporate & Commercial Team to arrange a conversation.

Key contacts Johnathan Rees Partner johnathan.rees@laytons.com +44 (0)20 7842 8009

John Gavan Partner john.gavan@laytons.com +44 (0)20 7842 8000

Cameron Sunter Partner cameron.sunter@laytons.com +44 (0)20 7842 8036

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This information is offered on the basis that it is a general guide only and not a substitute for legal advice.

We cannot accept any responsibility for any liabilities of any kind incurred in reliance on this information.

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