Over the previous six weeks, control-oriented non-public fairness funds (Sponsors) have been hunkering down with their portfolio corporations in gentle of the COVID-19 pandemic. Any and all ways have been thought of and applied with a view to protect liquidity, together with drawing beneath current revolvers, working with lenders for aid, profiting from loans and tax aid alternatives beneath the Coronavirus Help, Aid, and Financial Safety Act (the CARES Act) (if and to the extent accessible and even applied at the moment) and operational money administration with clients, landlords, and suppliers.
Regardless of these efforts, if the worldwide pandemic continues and/or if enterprise doesn’t bounce again rapidly sufficient, many portfolio corporations may have extra capital to maintain working. After exhausting all different cures, Sponsors with dry powder might should inject extra capital with a view to shield their investments at a time when valuations are decrease than prior financings.
Sponsor-led down spherical fairness financings include specific dangers that should be thought of, particularly in conditions the place the Sponsor controls a portfolio firm with many minority buyers. If continuing down this path, we suggest Sponsors take note the next:
Fiduciary Duties. Before everything, assessment the governing paperwork to verify whether or not fiduciary duties apply to administrators and controlling equityholders. Though fiduciary duties all the time apply within the context of a Delaware company, Delaware legislation supplies that fiduciary duties of managers, basic companions, and members of restricted legal responsibility corporations and restricted partnerships could also be waived if such waiver is expressly made within the relevant governing paperwork. When such waivers exist, managers, basic companions, and controlling equityholders could have broad discretion referring to a down spherical fairness financing (topic, in fact, to any contractually imposed limitations/duties within the governing paperwork and the implied covenant of fine religion and truthful dealing).
In conditions the place such waiver will not be made (or such waiver will not be in any other case permitted as a matter of legislation), controlling Sponsors and their appointed administrators should pay attention to their fiduciary duties. The place a majority of a portfolio firm’s administrators are appointed by a Sponsor, and the brand new spherical of fairness financing is led by such Sponsor, such administrators might be thought of “” administrators and won’t be protected by the enterprise judgement rule until sure of the steps mentioned within the subsequent paragraph are adopted. As a substitute, your complete equity commonplace of assessment will apply to the approval of such fairness financing and the administrators should show that the method was truthful and that the transaction was executed at a good worth.
If administrators exist, a portfolio firm’s board can take a number of of the next steps with a view to create a file that may assist the equity of its decision-making course of and the value, and even doubtlessly receive enterprise judgment rule safety:
- Kind an unbiased committee
- Acquire a equity opinion/interact a monetary advisor
- Take the deal to market
- Acquire disinterested/minority stockholder approval
- Doc the method
Combining an unbiased committee strategy with a requirement for disinterested/minority stockholder approval from the outset may end up in the transaction being evaluated beneath the extra forgiving business-judgment rule as a substitute of the exacting whole equity commonplace. Nonetheless, for a Sponsor with a middle-market portfolio firm, some or the entire above steps might not be sensible or cost-effective. As such, a Sponsor ought to contemplate the correct strategy given the information (e.g., the quantity of minority buyers, the dynamics amongst equityholders, the immediacy of the liquidity want, timing, the existence of preemptive rights) with its counsel with a view to pave probably the most protecting and industrial path.
Rights Underneath Equityholder Agreements. Sponsors and their counsel ought to assessment the relevant governing paperwork of the portfolio firm (whether or not that be the restricted legal responsibility settlement, stockholder’s settlement, or constitution) to judge potential restrictions or consents required with a view to facilitate a brand new fairness financing. Focus ought to be on the next:
- Minority consent rights
- Modification provisions
- Preemptive rights
If any of those minority protections exist, Sponsors ought to rigorously abide by the phrases with a view to guarantee compliance and keep away from any post-transaction disputes.
Impression on Credit score Paperwork and Lender Relationships. If no occasion of default beneath relevant credit score paperwork exists, a brand new Sponsor-led fairness financing is unlikely to provide rise to a compulsory prepay beneath a portfolio firm’s credit score paperwork. That stated, down spherical fairness financings are most frequently tied to monetary misery and covenant defaults and as such, protecting the road of communication open with lenders and understanding rights and obligations beneath the relevant credit score paperwork is essential throughout this course of. A Sponsor ought to take a holistic strategy, contemplating not solely the present liquidity must be glad by the fairness financing, however how and when to speak to lenders and whether or not to ask for sure lodging beneath the present credit score paperwork with a view to obtain liquidity and stop a future occasion of default. Such requested aid may embody:
- Materials loosening or “holidays” for monetary upkeep covenants
- Allowing some or all of curiosity and charges payable to be capitalized reasonably than money pay
- Deferring required amortization funds
- Carveouts and exclusions from sure monetary definitions and representations for COVID-19 and its results
Throughout the COVID-19 pandemic, we now have discovered lenders to be usually prepared to make lodging and work with Sponsors throughout this troublesome time (significantly these lenders that work intently with Sponsors on many various portfolio corporations). Relationships matter—and we consider lenders which are extra prepared to work with Sponsors will come out of this disaster stronger, having solid stronger partnerships with its Sponsors.
Communication with Key Co-Buyers. Typically occasions, the fairness capital stack contains co-investors and rollover buyers. These relationships typically run deep with Sponsors and are sometimes significant, particularly if the co-investors are additionally restricted companions within the Sponsor’s fund or if the rollover buyers are current administration. Sponsors ought to subsequently strategy key co-investors and administration equityholders prematurely of constructing the funding and ask whether or not they wish to take part contemporaneously and on the identical phrases because the Sponsor. Such companions will doubtless have protecting preemptive rights; nonetheless, we consider that socializing this transfer early pays dividends later in respect of future partnerships.
Impression on Administration Incentives. Extreme dilution of the administration group’s fairness might neuter current incentives that might in any other case have been vital to the corporate’s success in making an attempt occasions. Sponsors ought to contemplate different or supplemental choices to complement the compensation bundle (e.g., repriced choices or more money options) to make sure that the administration group’s incentives are appropriately aligned. Addressing this early and speaking with administration might be essential because the group navigates by misery.
The query will not be whether or not this pandemic will finish, however when. These portfolio corporations with liquidity would be the ones that survive this distressed setting. As Sponsors proceed to observe the liquidity wants of their portfolio corporations in addition to liquidity choices (together with different mortgage applications to be introduced beneath Title IV of the CARES Act), they need to be ready to tug the set off and supply fairness financing if the state of affairs requires it.