The COVID-19 pandemic’s effects have been unevenly distributed. Travel and hospitality companies that were extremely stable and successful until the spring have found themselves in extremely tough positions. In contrast, technology companies with far less secure business models have benefited from a ‘rising tide lifts all boats’ effect in the tech space.

As different European economies navigate new autumn and winter restrictions, continued uncertainty is not helping executives who are trying to look ahead to a post-COVID world. In November, I participated in a virtual forum on portfolio management at the FT Dealmakers Summit. Through the discussion, it became clear that there are a range of challenges facing private equity firms and portfolio companies. Which business models will be viable in a few months’ or years’ time? When is the right time to kick off a restructuring, should it be necessary? And what level of spending is right for different businesses in different sectors?

Portfolio companies: from crisis response to post-COVID planning

In recent months, private equity-backed companies have employed a range of tactics to minimise financial and operational pain where possible. Credit facilities have been drawn down, and business plans are being updated. And, of course, companies are exploring restructuring options where appropriate.

Conversations on equity and/or debt funding are also ongoing. Some PE firms are playing highly active roles in supporting portfolio companies: in recent weeks, we have seen Permira direct around £600m in new funding to credit services specialist Lowell and Blackstone provide £80m of support to events company Clarion.

Decisions like these are likely to be guided by the resilience of the portfolio company’s business model. If the PE firm has faith that a portfolio company has been badly hit by COVID, but that the business model and management team can respond to the significant challenges which still lie ahead over the next couple of years, then top-up funding makes sense.

Companies have been helped up to now by generally accommodating lenders and landlords. Certain covenants have been waived and repayment holidays have helped management teams take stock without having to countenance unpalatable waves of redundancies. But the situation is also creating a growing number of ‘zombie’ companies that are being propped up by government schemes and favourable renegotiations with creditors, but which will be essentially unable to compete when markets begin functioning as normal. Lenders will also begin to run out of patience.

Already, PE firms are weighing up which portfolio companies are likely to be victims of a permanently changed landscape. The numbers of zombie companies are starting to shrink, and we are getting a clearer sense of who the winners and losers will be a few months from now.

Rebounding: a question of timing

Even though European governments are continuing to provide support to companies into 2021, management teams are going to need to make decisions on redundancies and restructurings sooner rather than later. Companies that delay these decisions until furlough schemes run out will be behind the curve. Taking long-term decisions means being able to predict demand several months ahead, which has perhaps never been more difficult than at this moment.

Gauging the efficiency of capital expenditure is a critical task for portfolio companies and PE backers. Companies that are capex-heavy may have limited headroom to invest in operational transformations. These businesses will suffer. However, it is not just about cutting spending. We like to set ‘keep the lights on’ spending against ‘going for growth’ spending. Companies that have ambitions to capture market share from competitors in a volatile environment will need to spend money to achieve these goals. But inevitably, the risks of such a strategy are extremely high. PE firms need to enjoy a high level of trust in the management team to support these execution plans.

Some PE firms may also be looking at investment opportunities in this climate. Picking winners may come down to identifying companies and industries that have seen significant disruption, but which are simply more resilient than the competition. It may seem a little way off right now, but people will want to go on holiday and go to restaurants again. Portfolio companies that control spending and deal with restructurings decisively will be set up to return strongly post-COVID. In the meantime, a combination of robust risk management and supportive dialogue will serve PE firms well through what could still be a challenging few months.

How can A&M’s Private Equity Performance Improvement team help?

A&M’s private equity-focused professionals, underpinned by our leadership, action and results approach, understand the pace of play in private equity and prioritise the key areas of improvement that will positively impact EBITDA at the portfolio company level. Because we understand the unique opportunity for growth in the finite time frame of private equity funds ownership, we engage in portfolio company transactions at every stage — mergers and acquisitions, carve-outs, bolt-ons and divestitures.

If you have any questions regarding issues covered in this article, please get in touch with Amit Laud.