All signs are pointing towards the global economic fallout from the COVID-19 pandemic being far greater than the economic impact of the GFC, particularly after the unprecedented shutdown of non-essential services and the anticipated further lock down in the coming weeks.
In an effort to find some positivity in the increasingly sombre newsreel, in this article we look at 5 factors that may help those private equity funds most impacted by the crisis bounce back (which may not have been available during the GFC).
Dry Powder – private equity firms have more capital available to deploy than during the GFC.
Alternative sources of capital – there is a much larger alternative debt market available, typically offering more flexible solutions than traditional banks.
Safe Harbour – safe harbour provisions coupled with legislation introduced in the past weeks give directors more time to formulate and implement contingency plans.
Stand Down – the response by Government to the COVID-19 pandemic has, for some sectors, enabled activation of the stand down provisions under the Fair Work Act 2009 (Cth).
Team Australia - the Government, the RBA, regulators and industry have moved together in the past weeks to take unprecedented steps to offer solutions to businesses.
With the sand shifting daily, this article represents the position at the time of posting, noting that further stimulus measures are likely to be introduced over the coming weeks.
Private equity funds have a record amount of capital to invest. The Australian Investment Council Annual Report 2019 notes that at the end of 2018 there was US$14.8 billion committed for investments in Australia, compared to US$9.7 billion at the end of 2008. With the aggregate capital raised by domestic funds also tripling between 2011 to 2018, there is no doubt that funds now have access to more capital. While some of our private equity clients are sitting tight for the time being in terms of new investments or exits (while they assess the impact of the current crisis on their portfolio), this additional capital should enable them to take advantage of future opportunities which will no doubt arise.
Alternative Sources of Capital & ‘cov-lite’ structures
In recent years many domestic leveraged buyouts have utilised unitranche debt (a hybrid loan structure that combines senior and subordinate/mezzanine debt into one loan facility at a blended interest rate) or other ‘cov-lite’ structures such as Term Loan B. A private equity fund that has used one of these structures to finance a portfolio company may now benefit from their less restrictive requirements in the current uncertain climate - particularly as such debt structures usually allow for greater flexibility on companies incurring additional debt or disposing of non-core assets, and the nature of the ‘springing’ financial covenants which only apply once a certain drawing threshold has been met means if companies can manage their liquidity, testing of financial covenants can be avoided.
For private equity funds with portfolio companies struggling for liquidity, they may look to tap into alternative sources of capital. Credit funds and other alternative lenders have raised large amounts of capital over the past few years and, once the appropriate risks are quantified, we expect these lenders will be willing to deploy this capital for businesses seeking flexible liquidity to see them through the uncertainty ahead.
These lenders typically have a greater appetite for risk than traditional banks and have flexibility in structuring options that include capitalised interest, deferral of amortisation or balloon repayments, all of which can assist in relieving current pressures on cash flow by deferring the need to pay interest and make repayments during the current crisis (for further analysis, please see our earlier article Crisis credit: the role of private debt capital in volatile markets).
Directors can and should avail themselves of the safe harbour provisions to avoid the risk of insolvent trading. These provisions were introduced in 2017 and the coming period of widespread economic uncertainty will provide the first real test of the provisions. The safe harbour is designed to encourage boards to formulate a plan of action, in conjunction with advisors, that is designed to deliver a better outcome to the company than an immediate administration or liquidation (for further analysis on the safe harbour and the criteria for entry, please see our earlier article Safe Harbour – Common Questions and Misconceptions).
Additionally, in the past couple of weeks the Government has introduced emergency legislative changes which:
provide temporary relief for directors from personal liability for insolvent trading for a 6 month period;
increase thresholds for compliance for statutory demands; and
provide discretion for the Federal Treasurer to amend the Corporations Act 2001 (Cth) to relieve companies from certain obligations contained in the Act (although it is not yet clear what other obligations this will apply to).
For further analysis on the emergency legislation please see our earlier article, Updates to temporary relief for distressed businesses and individuals.
For impacted private equity funds, safe harbour plus the recent legislative changes referred to above may provide crucial breathing space for investor directors to assess their portfolio companies and develop and implement contingency plans in conjunction with suitably qualified advisors.
Section 524(1) of the Fair Work Act 2009 (Cth) allows an employer to stand down an employee without pay during a period in which the employee “cannot usefully be employed” because of a stoppage of work for any cause for which the employer cannot reasonably be held to be responsible. In the current context these provisions have been relied upon where there are health concerns as a result of COVID-19 which impact business operations or where governments have ordered mandatory shut-down of workplaces entirely. As painful as this is for those who lose their job, businesses (whether private equity owned or not) are utilising these provisions to create immediate cost savings – e.g. we have already seen Myer, Qantas, Virgin Australia, Flight Centre, APG&Co, Premier, and pubs and hotels group ALH standing down huge proportions of their workforce.
Questions still remain about what the appropriate measures for the Government are to put in place to help ‘revive’ the companies that enter hibernation during this period, including ensuring a return to full employment for those stood down as far as possible.
The Government announced yesterday that it will be introducing a $130 billion wage stimulus package to cover employees’ wages, in the form of a fortnightly wage subsidy (of up to $1,500 per employee) payable to eligible businesses, which must then be passed on to impacted employees.
Unlike the GFC, where Australia did not go into recession and was not as badly impacted commensurate to other countries (e.g. in 2009 unemployment was 5.5% and Australia’s debt to GDP ratio was 16.7% – whereas in the UK it was 7.6% and 63.7% respectively), the COVID-19 pandemic will hit hard. The ASX has fallen over 35% from its February high (although those percentages are changing daily given the market’s unpredictable reaction to the current period of volatility) and many economists are forecasting unemployment to rise above 10% (potentially as high as 15%) and the economy to contract by 5% (some saying as high as 10%).
These are startling numbers and coupled with the fear that COVID-19 may directly impact our own physical health or that of people we know, it is difficult to find positives in all of this.
One silver lining might be the speed in which Government (with rare bipartisan support), the RBA and industry have moved in the past weeks to take unprecedented steps to try and find solutions, as set out below:
Federal Government - Fast tracking the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) through both Houses of Parliament, which amongst other things, looks to give temporary relief to businesses and directors during these uncertain times (e.g. 6 month temporary relief from personal liability for directors from insolvent trading provisions in the Corporations Act) (for further analysis, please see our earlier article Updates to temporary relief for distressed businesses and individuals).
State Government – The introduction of the COVID-19 Legislation Amendment (Emergency Measures) Act 2020 (NSW) which amongst other things will have a significant impact on landlord tenant relationships as it grants powers to the Minister to recommend the introduction of regulations that may regulate or prevent the exercise or enforcement and/or impose restrictions on landlords in exercising certain statutory and contractual rights (e.g. the ability to evict a tenant for non-payment of rent where the tenant has been financially impacted by COVID-19). See our earlier article for further details of the predicted changes: COVID-19 Legislation Amendment (Emergency Measures) Act 2020: Important update.
RBA –The introduction in Australia for the first time of quantitative easing.
Treasury - The introduction of a range of tax support measures designed to provide key opportunities for managing cash flow. Provisions allowing, among other things, companies to vary company tax instalment rates which can generate refunds of previous FY20 instalments, immediately write off capital assets and accelerated depreciation on new assets, defer payments of tax and adjusting their GST filings to bring forward input tax credit refunds are just some of the new measures open to companies.
ABA - The recent decision by the banks (endorsed by the Australian Banking Association) to defer small business loan repayments for 6 months (freeing up $8 billion to support borrowers through the crisis) and the introduction of a scheme where the Government will guarantee 50% of loans to certain SMES, are hopefully the first of several positive steps the banking industry will take during this crisis.
ASX – The ASX has been more receptive to voluntary suspensions than any time previously to allow companies to suspend trading until they have raised funds, or assessed the impact of COVID-19 on their business, with media companies Southern Cross Austereo, Pacific Star Network and Ooh Media all electing to suspend their securities last week. It has also been reported that ASIC and ASX are intending to increase placement capacities from the current cap of 15% of shares on issue, to 25% of shares on issue.
ACCC – The ACCC has already shown some leniency in granting interim authorisation for the banking sector to co-ordinate small business loan relief and to the 4 major supermarkets to co-ordinate their response to panic buying, without falling foul of the cartel prohibitions. The hope is that this leniency is further extended to allow quicker execution of transactions and to encourage businesses to work together to find solutions.
FIRB – On Sunday evening the Federal Treasurer announced that it is temporarily reducing the foreign investment thresholds for foreign asset purchases and investments, which essentially means that most foreign investments are likely to require approval from the Foreign Investment Review Board (irrespective of the size of the transaction or the nature of the investor). It is likely the statutory timeframe for applications will also be extended from 30 days to 6 months. Whilst it is encouraging to see all regulatory authorities assessing how they can assist with the current economic crisis, we would question if this is the best approach given that now, more than ever, we need to support the flow of capital in the Australian market. See our article Putting the brakes on foreign investment – zero tolerance from FIRB for further discussion of these changes and practical implications for live deals.
Where the wheel stops spinning in terms of the scale of damage COVID-19 is to leave in its wake is yet to be seen and extremely hard to predict. For the time being, as a nation, our focus should be on adhering to Government guidance and encouraging others to do the same to help Australia pull through this period in the safest and quickest way possible.
If you have any questions about current events and how they may impact your business, please contact Gordon McCann (email@example.com), Zina Edwards (firstname.lastname@example.org) or Nick Edwards (email@example.com).
Hamilton Locke is a corporate law firm specialising in complex corporate finance transactions, including mergers and acquisitions, private equity, finance and restructuring, litigation, property and fund establishment. Hamilton Locke has considerable restructuring and turnaround experience across all relevant areas including finance, debt trading, loan to own transactions, distressed M&A, safe harbour, enforcement and insolvency.