Businesses are doing their best to carry on essential operations while simultaneously addressing all the new concerns the COVID-19 pandemic raises. Investment funds are no different; in addition to seeing to their own essential operations they also have to oversee, or in some cases, direct the efforts of a portfolio of companies in which they have made investments. Locke Lord has been at the forefront of advising and assisting our clients in maintaining a thriving business while staying on top of all new COVID-19 developments in their space. While we have provided a number of updates in the private equity space – all of which are available in our COVID-19 Resource Center – we have compiled a list of fundamental points below that highlight in one location a number of considerations that apply particularly to funds and their portfolio companies. This list is split into two parts, the first specific to funds, general partners and management companies and the second specific to portfolio companies.
I. Funds, General Partners and Management Companies
The following are general considerations for all funds, regardless of where any particular fund is in its life cycle:
a. Now is a good time to reread your fund documents, including any side letters, to confirm that none of them contain provisions (such as material adverse effect notice provisions) that could be triggered by the COVID-19 crisis.
b. Consider the affirmative step of personally reaching out to your limited partners to provide an update on how your firm is handling COVID-19.
c. On an ongoing basis, continue to update your internal policies and procedures as necessary based on your firm’s ongoing actual experiences as the COVID-19 crisis evolves. For example, your business continuity or succession plan or financial operations policies and procedures may need to be updated based on your firm’s actual experience with working remotely for an extended period of time. See our targeted articles As Companies Seek Alternative Ways to Sign Contracts and Other Records During COVID-19 Pandemic, E-Processes Take Center Stage and Privacy and Cybersecurity Work from Home Considerations in the Context of Coronavirus.
d. Review all of your firm’s insurance policies for potential claims. See our update on current trends for business interruption insurance: Business Interruption Insurance Coverage Litigation Arising from COVID-19. Consider whether your firm needs additional coverage it does not already have, or needs to change certain coverage limits.
e. Review your firm’s benefits plans and policies as well as group health plans. See our articles COVID-19 And Your Benefit Plans: What You Need To Know Now and Addressing Impacts On Group Health Plan Coverage Caused By COVID-19 Employment Changes.
f. Review material contracts, including leases, for notice requirements, force majeure provisions, termination triggers and breach/default provisions. See below for articles on some targeted topics you will want to address:
g. Consider whether your firm’s Form ADV or private placement memorandum should be updated to specifically or generally address COVID-19 or similar crises.
h. Develop alternative strategies than in-person meetings to keep your firm’s constituents – employees, current investors and potential investors – engaged and invested in your firm.
i. Review fund documents to determine if the likely decline in the value of the fund’s portfolio assets has triggered any investment restrictions, created a potential clawback situation, or created the need for additional reserves.
j. Review provisions addressing permitted investment entities, investment restrictions, and successor funds to confirm what other investments are permitted and what other business activities the fund might conduct should it opportunistically choose to do so. For example, funds may want to consider a temporary shift in strategy targeting distressed companies or providing direct lending.
k. Review the firm’s ability to, and the impact of, delaying payments under certain contracts to the extent helpful or necessary to maintain needed liquidity.
Although all issues raised here may be important to every fund, depending on the stage your particular fund is in and its particular geographic and industry focus, certain of these issues will have more immediate importance.
Raising Capital, Calling Capital and Maintaining Capital
a. If you are actively fundraising, consider seeking limited partner approval to push out any deadline for accepting new subscriptions.
b. Maintain in close contact with any firm lenders to confirm that any fund capital call lines of credit are still available.
c. If you are actively fundraising, consider proactively updating existing limited partners on how the fund expects COVID-19 to impact future fundraising.
d. Review any recycling provisions in your fund agreements and consider whether additional flexibility is desirable and, if so, consider seeking limited partner approval sooner rather than later.
e. Proactively review the limited partner default provisions in your fund agreements and consider what actions you can or must take in a default situation before an actual situation arises. Consider any flexibility that you could or would provide to limited partners who may default, such as extended capital call periods or extended grace periods.
Acquiring and Exiting Portfolio Investments
a. Your investment teams should revisit your firm’s standard investment due diligence questions and considerations, and update them as necessary to take into consideration COVID-19. These may include things like termination and force majeure provisions under material contracts, the ability of important customers and suppliers to continue to perform under material contracts, coverage under insurance policies, new regulatory concerns and their effect on ongoing business operations, and employment related concerns.
b. Evaluate how COVID-19 effects the factors your team typically uses to value a new deal, such as how heavily you want to rely on past performance measures; differences in what is now an appropriate level of working capital or reserves; supply chain, distribution chain and sole supplier concerns; and the likely decline in the availability of debt financing or lines of credit.
c. Review any M&A representation and warranty insurance policy carefully, as insurers are now expressly adding COVID-19 exclusions to these policies.
d. Be prepared to provide various constituents – the representation and warranty insurance policy carriers, your limited partner advisory committee, co-investors and lenders – a detailed analysis of how COVID-19 will affect your transaction and the underlying business of the portfolio company.
e. Take a second look at those default “market” provisions in your acquisition agreements in light of how COVID-19 may have effected your position. These should be reviewed on both the sell and buy side. Some particular provisions to focus on are:
- Representations and Warranties.
- Financing Covenants.
- Regulatory Covenants. For example, approvals of transactions by various regulatory bodies will likely be delayed and may ultimately delay closings if they are a condition to close. The FTC at one point indicated that early terminations of the HSR waiting period would not be granted, but then quickly announced that they would resume the practice of early terminations staring March 30, 2020 (FTC Announcement).
- Interim Operating Covenants. Normal operations of target companies are bound to change in order to address COVID-19, and as such, companies may inadvertently breach ordinary course operational covenants between sign and close.
- Termination Provisions. Be prepared to fund reverse termination fees if lenders do not fund when required.
- Definition of Material Adverse Effect. MAE will typically effect both rights to terminate an acquisition agreement and the parties’ abilities to bring down representations as a condition to closing. COVID-19’s impact on MAE clauses must be analyzed and considered on a case-by-case basis depending on the specific carve-outs in the MAE provision and the timing of when the MAE is being analyzed.
- Special Indemnities. Special provisions may need to be added to investment or acquisition agreements to address known COVID-19 related liabilities or COVID-19 related liabilities or costs that arise down the road.
Maintenance of Operations and Winding Down
a.Consider whether it would be prudent to exercise any rights to extend the fund’s investment period or, if needed, seek limited partner approval to extend the investment period.
b. Consider your willingness, and ability under your fund documents, to enter into guarantees or functional alternatives such as make-wells or equity contribution agreements to assist struggling portfolio companies.
c. Continually consider the impact of COVID-19 on the valuation of your existing portfolio companies. Review your policies and procedures for ongoing valuations of the fund’s portfolio and consider whether any changes are necessary or desirable in the current environment. Consider running new procedures by any trusted third party experts, your limited partner advisory committee, auditors, or tax advisors.
d. Analyze the likely willingness of your current limited partners in any fund that is currently in or shortly will be in wind down mode to roll over any unfunded commitments into a successor fund as a way to ensure the continuity of subscription commitments.
II. PORTFOLIO COMPANY CONSIDERATIONS
a. Review each portfolio company’s material contracts, including leases, for notice requirements, force majeure provisions, termination triggers and breach/default provisions. See below for articles on some targeted topics you will want to see your portfolio company addressing:
b. Review the portfolio company’s ability to, and the impact of, delaying payments under certain contracts to the extent helpful or necessary to maintain portfolio company liquidity.
c. Refresh marketing materials and any standard contracts to include COVID-19 provisions, warnings and disclaimers as needed. Take special note of any contracts contemplating in person contact or marketing materials encouraging in person contact.
d. Review your portfolio companies’ insurance policies for potential claims. See our update on current trends for business interruption insurance: Business Interruption Insurance Coverage Litigation Arising from COVID-19. Consider the need for any new or additional coverages or limits for some or all of the fund’s portfolio companies. Review any new policies carefully to be sure coverage does not exclude COVID-19 related claims.
a. Review your portfolio companies’ various policies and plans effecting employees. Below are a few examples of policies and plans that should be considered and reviewed:
b. Continue to review and refresh yourself on state and federal laws that will likely be implicated, and be apprised of all relevant legislation going into effect, including the following:
The Coronavirus Aid, Relief, and Economic Security Act or the “CARES Act”.
i. CARES Act Guide: Overview of Key Employee Benefits Provisions
ii. CARES Act Guide: Overview of Executive Compensation Limits
iii. CARES Act Guide: Overview of Key Unemployment Provisions
iv. UPDATE On The Families First Coronavirus Response Act (FFCRA) Leave Protections Following Updated DOL Guidance
c. Review any collective bargaining agreements and consider any impact on the portfolio company’s obligations thereunder.
d. Review incentive equity plans and consider the need for restructuring due to COVID-19’s impact on valuation and ongoing operations. Note participation thresholds and performance metrics.
e. Consider taking advantage of the provision of tax-free financial assistance to employees affected by coronavirus under the Robert T. Stafford Disaster Relief and Emergency Assistance Act a/k/a the Stafford Act. See here for further information: Employers May Offer Tax-Free Financial Assistance To Employees Affected By Coronavirus Under Internal Revenue Code Section 139.
a. Review your portfolio company liquidity needs. Consider having one or more portfolio companies draw down on revolvers now, while they are still able, to the extent the company is still compliant with the covenants thereunder.
b. Review and refresh your understanding of your portfolio companies’ credit agreements. Take note of any applicable provisions including:
- Tripped financial covenants and the extent to which relief from lenders, equity cures, and covenant resets are available.
- Triggered notice requirements.
- Default provisions, including a review of grace periods to cure defaults. Consider requesting forbearance agreements and amendments to address any defaults.
- See here for additional considerations: Coronavirus and the Credit Markets: Borrower and Lender Concerns.
c. Refresh portfolio company boards of directors on their potential duty to consider creditor interests in addition to equity holder interests when addressing solvency concerns.
d. Consider exploring more EBITDA add-back flexibility. EBITDA add-backs are increasingly being examined to determine their applicability to lost income and increased charges or expenses related to COVID-19.
e. Monitor deposit account balances and consider whether lenders may have set-off rights against such accounts.
f. Review the CARES Act to confirm whether your portfolio companies may take advantage of the loans offered thereunder. See here for further information: Saving Our Small Businesses: CARES Act Expands Economic Injury Disaster Loan Program to Provide Additional Financial Relief to Small Businesses.
Tax and Regulatory Matters
a. Review the tax benefits under the CARES Act to determine whether your portfolio companies are eligible for certain tax deductions or benefits thereunder. See here for further information: UPDATE: CARES Act Guide: Overview of Key Business Tax Provisions and CARES Act Guide: Overview of Expanded Charitable Contribution Limits.
b. Consider taking advantage of any state and federal extensions for tax filings. See here for further information: Federal and State Governments Begin to Provide Economic Assistance via Tax Relief in the Face of COVID-19 Economy Disruptions.
c. Anticipate and plan for long waiting periods on all regulatory approvals.
d. Stay apprised of actions and opinions being issued by regulatory bodies governing your portfolio companies. Consider implementing designated individuals at the firm to continually monitor ongoing developments at one or more portfolio companies.