PE Fund Activity Slumps to A Two-Year Low, hit By the Coronavirus Pandemic

Summary

• Worldwide Private Equity firms raised around $116 billion in funding during the April to June quarter, which is the lowest since the first quarter of 2018
• Following the lockdown, in major cities in Europe, 45 Private Equity and Venture Capital funds have raised nearly $36.5 billion for investment in European companies.
• The biggest impediment in raising capital that PE funds are facing is the inability in making a face to face meetings, because of the lockdowns and social distancing measures

The outbreak of the coronavirus pandemic has had an adverse impact on the working conditions of most companies worldwide. While most of the businesses experienced a significant downturn in their business activity levels, heightened volatility stopped investors and bankers from investing and lending their money into new and risky ventures. The ensuing impact on the investment environment thus became all the more challenging for new start-ups who were looking to raise capital for the first time and for firms who had already gone through a few rounds of funding and were in line for the next few. Apart from a liquidity crunch, most PE funds and venture funds are also facing the challenge of not being able to meet the fund seekers face to face, which is proving to be a major hindrance. Most PE and VC firms prefer to finalise deals after in-person meetings with the fund seekers and not through virtual meets, as they could be dealing with investment size that could be anywhere between several million to billions of pounds. The general risk levels thus have risen significantly across the industry, and most funds it seems would wait until better times come to prevail before they are ready to take in new commitments.

How has coronavirus pandemic impacted business activity and investment landscape?

Private Equity funds and Venture capital funds are businesses that have the highest appetite for risk as they invest in businesses where banks and other financial institutions are shy to invest. These funds play a very crucial role in supporting businesses in their early stages, when they have no revenues and are struggling to gain scale. After having gone through their early phase of struggle when these companies have grown sufficiently enough, the PE funds and VC funds sell their stake and make profits.

The impact of the pandemic did not just impact the margins of large companies but also slowed down the expansion plans of small and start-up companies. The difficult market conditions not only meant that the growth plans for many of these companies got delayed, but it also meant that many of them would not be able to survive through this ordeal.

Thus, the fundraising activity levels in the industry have slowed down as fund executives have now become more diligent than ever in their scrutiny of new investment avenues and slowing down on their existing funding commitments. The pandemic also widened the gap between larger and smaller PE and VC funds this year, The larger funds which are able to better withstand risk had a significant advantage over the smaller ones as the largest five funds this year accounted for nearly a third of the capital raised by the industry.

Why is the issue of liquidity so critical for PE funds?

Liquidity and the fear of adequate availability of liquidity due to the deteriorated market conditions is also a major factor that stops investment managers of PE’s and VC’s from making new funding commitments. The lockdown and the increased risk perception of banks, financial institutions and even individual investors mean that very few are willing to let go off cash prompting the managers of these funds to also hoard cash till the conditions improve across the economy.

Volatile market conditions also increase the risk levels for the existing investments made by these funds. Most of the portfolio investments of these funds are start-up’s that are at various stages of receiving funding and face the risk of failure if cash flow is abruptly withdrawn. Thus, an investment manager must also maintain adequate liquidity levels to protect these investments during difficult times.

Periods of economic uncertainty for a PE and VC firm also means that the rate of returns on their investments diminishes. Since this is their major source of income, PE and VC funds may face a crunch in generating sufficient cash flows to run their day to day operations during such periods, which necessitates a judicious allocation of existing resources.

What is the British government doing to support start-up’s?

To alleviate the funding problems of the start-ups in the country because of the pandemic, the British government had rolled out a scheme in the month of April. The stimulus package which was exclusively meant for the start-up businesses in the country intended to augment the efforts of these companies and their funding partners fight through the pandemic and protect the valuable work that they had already done. The fund which was worth £1.25 billion in total was divided into two parts, the first part is known as the "Future Fund" and was valued at £500 million, especially meant for equity infusion, whereas the other £750 million would be for loans and grants. While the loans and grants will be given on a need-based case to case basis the rules for Future funds is a bit stringent. A start-up under this scheme can apply between £125,000 to £5 million from this fund as long as they are able to raise a similar amount from private investors and have raised at least £250,000 in equity funding in the past five years. The funds availed will automatically be converted into equity at a 20 per cent discount to its valuation that would be set for its next round of funding unless the business decides to repay it to the government.

The industry experts, however, are hopeful that, the business environment for the PE and VC funds will improve in the near future as new investment avenues are emerging with immense value creation potential.