New Approaches to Private Equity, A Crain’s NY Business Roundtable featuring Matthew John McNally
This article originally appeared in crainsnewyork.com
In 2020, private equity firms and their portfolio companies experienced the same pandemic-fueled economic shocks as every other business. But because of specific eligibility criteria, many PE firms did not qualify for forgivable loans from the Paycheck Protection Program instituted by the CARES Act. Now PE firms are looking for growth opportunities in a low-asset-value environment. They’re also taking on an expanded role in shepherding their portfolio companies through an uncertain economic future that may include future lockdowns in response to a resurgence of COVID-19 infections.
To learn how the pandemic and its aftermath has changed private equity firms’ approach to mergers and acquisitions, due diligence and other decisions as well as how they’re preparing for a “new normal,” Crain’s Content Studio turned to three experts in the private equity field:
Elena Newman, partner in financial services at EisnerAmper
Matthew John McNally, managing director of True Partners Consulting
Anthony Tomaro, partner and consulting services leader at Grassi Advisors & Accountants.
Following are Matthew John McNally’s insights into the opportunities and challenges shaping firms’ decision-making processes.
Crain’s: How has the pandemic changed private equity firms’ and their portfolio companies’ approach to deal making, risk assessment and other strategies?
Matthew John McNally: The private equity industry has been significantly altered by the pandemic and is just now starting to see signs of recovery. With uncertainty now the new normal, deal strategy and risk assessment has been momentarily altered and heavily concentrated in the distressed, opportunistic and strategic-alliance areas.
Crain’s: What are portfolio companies expecting from private equity firms in terms of assistance during the pandemic? How can PE firms help portfolio companies with cost containment?
McNally: Since the pandemic, many private equity firms have been compelled and in most cases obligated to increase support for their portfolio companies. PE firms should seize this opportunity to build more robust relationships. As portfolio companies look to the PE firms for guidance, the firm has a platform to showcase their industry expertise and build rapport. PE firms that can develop strong relationships with their portfolio companies are better positioned to build growth and have a smoother transition upon exit.
Cost containment can be achieved in a multitude of different ways depending on how the private equity firms are structured and how the legal agreements are written. Here a few examples: A typical PE firm should look to reduce expenses by consolidating any redundant administrative and back-office work throughout its portfolio of funds. Build a portfolio committee that brings together the heads of each of the portfolio companies to share experiences and find solutions to problems as a team. Speak to your professional-service providers and see if they are willing to negotiate on fees. Engage a cost-reduction service provider to work with the portfolio companies to reduce indirect procurement costs and increase productivity.
Crain’s: How has the CARES Act affected the private equity industry?
McNally: The CARES Act provided financial relief to support businesses during the COVID-19 pandemic. The Act permitted a majority of private-equity-owned portfolio companies to participate and provided critically needed liquidity to stem the downturn. The liquidity provisions of the CARES Act gave portfolio companies the ability to borrow funds through the expanded Small Business Administration loan program with deferred payroll tax liability and credits against particular employee taxes.
Crain’s: What kind of due diligence is required as PE firms use a low-asset-value environment to grow their portfolios?
McNally: Private equity firms should integrate due diligence procedures and reviews from the date of purchase until the date of exit. This will give the PE firm a true macro and micro view of the company’s competitive realities, as well as its regulatory and legal reporting requirements, taxation and management bandwidth. True insight can be achieved through unified due diligence procedures and periodic testing.
Crain’s: How can PE firms sell assets at an optimal price in a distressed economy?
McNally: The COVID-19 pandemic has had a devastating impact on the economy and an increasing number of companies are under extreme pressure. A healthy and well-capitalized portfolio company before COVID-19, today could be a company on the brink of bankruptcy. The private equity firm must devote itself to building up its weaker portfolio companies’ balance sheets and operations, accelerate transformation and most importantly create value. PE firms need to build a systematic approach to value creation, for the time being placing less emphasis on operational performance. Healthier portfolio companies can focus on reinforcement of their positions and growth.
Crain’s: What should investors know about the increasing popularity of SPACs in the PE space?
McNally: Special purpose acquisition companies (SPACs) are essentially blank-check funds that are designed exclusively for the purpose of acquiring and/or merging companies. It was estimated by the year 2025 that SPAC IPOs’ value will be approximately $80 billion in the United States, with 2020 on track to be another record-breaking year. However, SPACs come with a tremendous amount of uncertainty. On Sept. 21, 2020, the Securities and Exchange Commission issued new guidance requiring SPACs to satisfy the eligibility requirements for registering securities on Form S-3, the short-form registration statements. This of course comes with additional administrative requirements and increased cost.
Crain’s: What can firms do now to prepare for future surges of COVID-19?
McNally: Firms should make technology an integral part of the business and a world-class data capability should be developed. They should make sure employees are equipped with all the necessary tools and equipment to be able to work both efficiently and effectively remotely. They should implement additional cybersecurity, as remote workers are more susceptible to hackers and phishing attacks. They should make communication simple, build and save cash reserves and cut extraneous expenses. Firms should apply for available relief funds and try to develop new revenue streams.
Crain’s: What do new consumer habits mean for the future of private equity?
McNally: COVID-19 has shifted consumer spending towards health and wellness and is reinforcing the trend toward healthier foods and lifestyle. Consumers are reluctant to spend on luxury goods and have increased savings given the uncertainty of future lockdowns. Some private equity firms will see this as an opportunity to identify a role for M&A in their portfolio companies, undertaking acquisitions in the consumer goods market to pursue inorganic growth or divestitures to fuel growth elsewhere.