The coronavirus epidemic poses a specific threat to secondaries dealmaking due to the way portfolios are priced and the global nature of the underlying assets, Debevoise & Plimpton has warned.
Covid-19 presents “significant challenges” for the secondaries market where pricing of fund interests is based on historic pre-signing net asset values and where large, complex deals often have lags of several months between signing and closing, the law firm wrote in a note to clients on Monday.
“We can expect secondary buyers to explore creative means of price protection in purchase agreements, while secondary sellers may face difficult decisions around accepting price reductions, price uncertainty and/or transaction risk,” Debevoise wrote.
The firm expects buyers may seek simultaneous “sign-and-close” agreements on transactions, the right to renegotiate pricing agreements, or even including clauses that give them the right to walk away from a deal such as material adverse change or force majeure clauses that account for unexpected events.
Coronavirus has infected more than 100,000 people worldwide, according to the World Health Organisation. Italy has the highest number of cases outside of China, with more than 10,000 cases reported and the entire country on lockdown.
Private equity investors including Blackstone have warned of the “material” threat posed by the epidemic to fund performance, as reported by sister title Private Equity International, while a spokesman for KKR confirmed the buyout firm had temporarily closed its London office due to a member of staff having contracted the virus. Bain Capital is also understood to have temporarily closed its London office on Wednesday for the same reason.
The nature of secondaries portfolios being global – underlying portfolios typically comprising assets operating in multiple geographies and relying on worldwide production and supply chains – makes drafting appropriate and effective MAC clauses particularly challenging, Debevoise noted.
In addition, the relationship-driven nature of the secondaries market makes it more challenging for buyers to include MAC clauses in deal documents, Andrew Rearick, counsel at Debevoise, told Secondaries Investor.
“Customary MAC clauses may not be the best tool in the secondaries market – in traditional M&A they invariably lead to a fight if they are invoked,” Rearick said. “In the secondaries market, where buyers and sellers are relationship-driven, there may not be much appetite to use a provision that inevitably has wide interpretation and could cause such bitter interpretive disagreements.”
Secondaries buyers will likely seek to negotiate MACs with more objective triggers, such as negative changes to exchange rates or performance of comparable public equities between the singing of the deal and closing, Rearick said.
Buyers may also attempt to reduce the lag between signing and closing, or by submitting letters of intent that are non-binding, he added. Deferring entry into a purchase agreement for as long as possible, or asking the seller to front-load the process and price the deal at the last minute can help mitigate risk during periods of volatility.
“From a buyer perspective, compressing the timeline will at least reduce their exposure to overpaying up front,” Rearick said.
– Carmela Mendoza and Rod James contributed to this report.