While no one should ever lose sight of the fact that the coronavirus pandemic is, first and foremost, a public-health crisis that has seen thousands die in the U.S. alone, the economic implications cannot be ignored, as they too have been devastating.
That has never been clearer than it is in the business development world, where deal-making came to a virtual standstill in the all-important spring window, a time of year when private equity firms are busy closing deals. There was talk of borrowers defaulting on loans, talk of lenders struggling with portfolio issues, talk, even, about whether much of any deal making will happen in the year 2020.
The pandemic has been, in short, the quintessential black-swan event — i.e., an unexpected occurrence that has made a shockingly severe impact. Few foresaw this happening, even in the early days of March. And it has unfolded in real time, leaving investors and managers alike bracing for whatever might come next.
Some of my business efforts include sourcing investment opportunities for the Business Development Company (BDC) space where no company has been immune from the market decline.
On March 21, the Wall Street Journal declared that two of the larger BDCs, FS KKR Capital and Ares Capital, had lost 60 percent and 45 percent of their value, respectively, as individual investors grew skittish. On April 6, Fitch Ratings downgraded BlackRock Capital Investment Corporation, the world’s foremost asset manager.
Two days later, analysts for Moody’s Investor Service wrote in a report that BDCs were likely to be the sector “most affected by this credit shock,” and dropped their rating from “stable” to “negative.” And on April 16 Reuters reported that Golub Capital and Gladstone Capital had dramatically cut their dividends.
And on and on it went.
Various life preservers were tossed in the direction of the $110 billion BDC industry, which represents a sizable sliver of the $812 billion private credit market. The Federal Reserve came through with the Main Street New Loan Facility and the Expanded Loan Facility, which earmarked $600 billion for small businesses. The Small Business Administration offered up the Paycheck Protection Program, with loans to the companies in that same sector (but places restrictions on those owned by private-equity firms). The SEC also announced temporary regulatory relief that would allow BDCs to continue investing in small to mid-sized businesses.
But it was unclear how much, if at all, any of these measures would enable BDCs to ride out the storm. What seemed far more likely is that some companies would be shuttered or gobbled up by their larger brethren, as was the case following the Great Recession of 2008-09. Particularly notable at the time were Ares Capital’s $648 million acquisition of Allied Capital, and its $3.4 billion acquisition of American Capital.
Those companies that have continued to tread water during the present crisis have turned inward, evaluating where matters stand with all their investments. Some industries such as B2B software appear most likely to hold their value throughout the pandemic, while those in such areas as hospitality, entertainment and retail seem far less likely to do so.
Portfolio diversification is, as a result, crucial to survival. So too is maintaining liquidity, as that allows a BDC to pay dividends and help the companies in its portfolio overcome whatever cash-flow problems they might encounter. That may, as author/advisor Rida Morwa suggested in a piece for Forbes, involve providing relief for something like a rent or loan payment. Whatever the case, liquidity is vital — something that was made clear when the aforementioned firm, Golub, made a rights offering through which it hopes to raise over $300 million. Bain Capital Specialty Finance announced it will make a similar move.
What does all of this mean for the current state of deal making?
1. It has put a premium on existing, trusting relationships.
Having a great relationship with those you do business with has always been important, but never more so than now. When bad news strikes, those who can rely on their partners for accurate, timely information will be able to make much better decisions than those left in the dark. Through this crisis trust will as often be confirmed and as it will be violated. Do you trust those you do business with?
2. It will define their reputation as they plan a path forward during recovery.
It is at a time like this when reputations are forged. And with social media far more prevalent than it was during the Great Recession, more and more stories of good behavior on the part of investors — as when they support companies and their employees — will no doubt be circulated. So, too, will stories of bad behavior which I fear will be far more common. The private equity industry has many more public critics than sympathisers.
3. It has highlighted the importance and value of using technology to stay connected and maintain the strength of relationships.
Zoom usage has in particular spiked. As of late April the video conferencing platform had 300 million daily users, up from 200 million earlier in the month — and up from 10 million in December. As for LinkedIn, Forbes contributor William Arruda pointed out that there are several common-sense ways in which the platform can be used during a time when many are working remotely.
The good news is that the markets will recover. People will go back to work. And the strong companies that come out of the crisis will be positioned to grow. As noted by Fitch Ratings, the top companies in the sector, who have no debt maturities until 2022, have a better chance at coming out the other side intact. It might be difficult for any of them to know the timing of this, amid an unprecedented crisis, but there is hope.