COVID-19 is creating a dramatic impact on the global economy, and likely will continue to do so for a significant part of the year. This pandemic creates previously unseen challenges to portfolio companies, as well as associated risks and opportunities. Private Equity sponsors can help address these challenges by developing frameworks to evaluate and support their portfolio during this quickly evolving business environment.
We have identified several leading practices and considerations for Private Equity sponsors as portfolios pivot to address the operational and financial challenges presented by today’s environment.
1. Establish COVID-19 Response Team (RT) or Impact Program Management Office (IPMO)
COVID-19 represents a rapidly evolving crisis with data points changing multiple times per day. To be effective in monitoring, consuming, and actioning that information, sponsors should create a Response Team (RT) or Impact Program Management Office (IPMO) to drive the development and execution of an action plan to support portfolio companies with clear communication and directives.
Key responsibilities of this team include:
- Create a prioritization of support across the portfolio.
- Identify portfolio companies experiencing counter cyclical support.
- Plan for a range of disruptive scenarios with potential outcomes and response.
- Develop a communication plan to limited partners, portfolio companies, and other stakeholders.
2. Assess Business Continuity Plans for Portfolio Companies
COVID-19 has drastically changed the way in which we work in a very short amount of time, and it may continue to disrupt normal operations for the foreseeable future. Portfolio companies must be evaluated to understand operational risks and develop short-term workarounds and more sustainable long-term plans that align to the investment thesis.
Key actions items include the following:
- Evaluate the risk to employees’ and customers’ health, safety, and productivity.
- Ensure continuity of critical processes.
- Understand potential IT and cybersecurity risks arising from operational model changes.
- Assess reliance on offshore resources and their ability to work from home.
- Review insurance policies to assess potential recoveries for any business disruption.
3. Evaluate Portfolio Company’s Liquidity Position and the Availability of Credit
In this period of uncertainty, it is critical to assess liquidity under various scenarios and develop and implement an appropriate cash-management strategy. A better understanding of fixed versus variable cost drivers is necessary to identify potential cash savings and make more proactive decisions, despite uncertainty in revenue forecast. Businesses should have a comprehensive view of the various sources and uses of cash to identify cash-generating and -preservation levers.
Specific activities include:
- Sharpen the view on the traditional 13-week cash forecasts with daily forecasts.
- Prepare a detailed working capital diagnostic and optimization plan.
- Assess liquidity, including covenant requirements, and leverage optionality when available.
- Review and monitor obligations under financing arrangements.
4. Perform Scenario Modeling and Business Planning
COVID-19’s impacts have been deep and sudden on today’s economic environment. However, the longer-term impacts and overall capability of the economy to rebound is somewhat uncertain. Portfolio companies should re-forecast planned financial results to consider varying scenarios to help understand the impact and effectiveness of adjusting certain levers, and therefore, drive strategic decision making to stabilize value.
This analysis should consider the following:
- Stress-test financials against a variety of scenarios and expand modeling capabilities.
- Identify short-term revenue risks and related impact.
- Evaluate and assess the impact of cost savings measures.
- Identify efficiency gains in the company’s operations.
5. Track and Monitor the Impact of the Disruption to Normal Operating Cycles Related to COVID-19
As portfolio companies regularly present normalized earnings, both revenue and EBITDA, reflecting add backs from non-recurring (or extraordinary or unusual) items, it will be important to be able to track and quantify the financial impact of COVID-19. This is especially critical in the Private Equity environment, where sponsors may be looking to exit the investment within the next 1-3 years. Models that are precise and based on a "bottoms-up" build are more likely to stand up to diligence procedures and drive higher valuations than models that are less supported.
Private Equity sponsors will need to continue to assess the impact of COVID-19 on their portfolios to help stabilize the fund value. This presents a unique challenge for which there is no specific formula during this unprecedent pandemic to ensure success. Leaders that are able to effectively analyze their risks and develop appropriate plans are much more likely to ride out the storm, while others will struggle to execute on the investment thesis. Providing clarity around the approach to mitigate these challenges will help to develop trust amongst all stakeholders, which is critical to success in these tough times.
Our latest guidebook provides leaders with a roadmap to enhance resiliency plans, simplify operations, address new financial requirements, and more. To download, please click the link below.