The coronavirus pandemic has created a series of unprecedented challenges for general partners of closed-ended private funds in relation to the capital raising and operation of their funds. We have seen a number of topics developing over the last two weeks. This client alert provides a list of "hot" topics to be put on the radar and, as the case may be, to act upon
We expect the timelines for fundraising to be impacted by: (a) the uncertainty and market turbulence stemming from the pandemic; (b) liquidity constraints on investors resulting in a reduced appetite to enter into new long-term capital commitments; (c) the challenges for fund investors to undertake their due diligence (in particular, face-to-face meetings), receive appropriate internal approvals and obtain relevant signatures; and (d) to the extent a fund has existing investments in its portfolio, the difficulties around determining the valuation of those investments. Accordingly, a GP raising a fund should check the duration of the fund's fund raising period and the approvals required to possibly extend it, and evaluate whether it is prudent to build in greater flexibility so as to achieve a successful fundraising.
Investment Objectives and Investment restrictions
The significant market dislocation brought about by COVID-19 is likely to result in some GPs considering alternative investment options, such as investing in distressed opportunities. Such GPs will need to revisit their investment objectives and investment restrictions to determine whether or not they have the ability to deploy capital into these asset classes, and if not what consents are required from investors to broaden the remit of their investment policies. It should be noted that significant amendments can be difficult to obtain. Those GPs looking to reshape their investment policies should also make sure they fully understand the legal, regulatory and tax considerations of investing into these new asset classes.
Valuation Considerations during Fundraising
Prospective investors considering investing into funds, which already hold assets may be particularly focussed on the valuation of those assets and may hold off on committing to the fund until they have a better understanding of those assets' value. Furthermore, the equalisation payment (being the amount paid by later-close investors to existing investors on admission to compensate existing investors for the time their capital has been tied up in the fund) will also be of interest to both existing and prospective investors. In such uncertain times, GPs will be required to see if and, if possible, how they will deal with requests in this respect.
GPs should expect that branches of the government or supervisory bodies will be shut down or suffer significant capacity constraints for the foreseeable future. GPs should make required filings as early as possible to mitigate delays in the fundraising process and should work with the applicable government or supervisory authority to determine how to tackle these matters.
2. FUND OPERATION
We are seeing GPs either delaying in-person investor (e.g. one-to-one, limited partner advisory committee (LPAC) and annual) meetings or switching to tele- and video-conferences. GPs typically have a material level of discretion over the manner in which such meetings are held. However, GPs should check the relevant provisions in their fund documents to ensure they are in compliance or, if required to have in person meetings, consider obtaining a waiver from the relevant parties.
Limited Partner Advisory Committee
The volatile market environment may result in increasing engagement with the fund's LPAC. GPs should ensure they understand the remit and duties of the LPAC and maintain a healthy dialogue with this key investor body. In addition, GPs should be alive to the potential conflicts that LPAC members may face.
In a time of such uncertainty, GPs should consider reaching out to the existing and prospective investors in their funds to see how they are working through the challenging business environment and whether they have questions. In particular, we recommend that GPs ensure they are being consistent with the types of information and responses that are provided to investors (both existing and prospective) to mitigate selective disclosure issues.
GPs should ensure that they are complying with and reviewing their own business continuity plans. If applicable, GPs should furthermore be checking in with key service providers (e.g. depositories, valuators, etc.) to confirm that such service providers are continuing to provide consistent service in light of COVID-19 and whether any disruption should be anticipated. Also, GPs should consider whether any back-up services are available if one or more service providers were to experience an ongoing interruption of service, in particular for those services that are critical to the proper functioning of the GP's business.
Many fund-level financial statements rely on the delivery of information from portfolio companies (which may be delayed given the current market volatility). GPs should check their fund documents to determine the deadlines and whether these deadlines are fixed or, alternatively, permit the GP to use its best endeavours (or some other threshold) to satisfy them. GPs should engage with their portfolio companies, auditors and other stakeholders as to the feasibility of meeting the applicable deadlines.
We expect that a serious or protracted market downturn will result in an increase in investor-led secondary activity. For example, investors who are facing near term liquidity needs, or are over-exposed to certain assets, will likely seek to resolve these issues by turning to the secondaries market. Likewise, GP-led secondaries will likely provide additional liquidity avenues for investors and/or funds to dispose of certain assets.
Where a fund is nearing the end of its fund term, GPs may want to consider seeking an extension to provide additional time to allow maturing investments to stabilise in the event of a protracted financial downturn.
3. FUND INVESTMENT
Investment Period Extensions
GPs with a fund nearing the end of its investment period and capital to deploy will need to check whether or not there is sufficient flexibility in the fund's documents to extend the investment period. GPs should look to act promptly when seeking extensions so as to give themselves sufficient breathing space to draw on the requisite unfunded commitments at the appropriate time. However, typically there is a step down on management fee at the end of the investment period so communication with investors on this point may be central to avoiding issues later.
Additional Funding for Existing Investments
It is likely that we will see portfolio companies requiring additional sources of capital to support them during this challenging time. Fund documents typically impose constraints on the amount and timing of follow-on investments and GPs will need to evaluate the limitations that apply to their funds. If there is limited capacity to access follow-on capital, GPs may need to consider seeking an amendment of the respective rules.
Contingency planning for defaulting investors
GPs should consider what features are at their disposal in the case of an investor being unable to meet a capital call. This includes both calling additional capital from non-defaulting investors to make up the difference and employing a subscription facility. GPs should pay attention to the prescribed limitations set out in their fund documents when using such forms of capital.