By Benjamin Horney

Law360 (March 23, 2020, 6:30 PM EDT ) The private equity industry is not immune to the effects of the coronavirus outbreak, but fund managers are showing a resilient desire to continue doing deals and raising funds despite significant challenges, underscoring the need for legal counsel that can help clients come up with creative solutions.

The spread of the virus has led to extreme social distancing in the U.S., which is causing economic turmoil, although there are those in the business community who believe the economy will bounce back once the health crisis is under control. The world of mergers and acquisitions has been greatly affected by the pandemic, and, for now, nothing is business as usual when it comes to private equity dealmaking and fundraising. But fund managers have an entrepreneurial spirit that is hard to crush, and attorneys are finding that their PE clients have no intention of sitting on the sidelines and waiting for the coronavirus chaos to pass.

"While the PE industry remains extremely well-positioned to weather this storm, the impact of the coronavirus has been profound," said Peter Gilman, a corporate partner at Simpson Thacher & Bartlett LLP.

Gilman said the pandemic has affected all aspects of private equity firms' operations — from financing and closing deals to fundraising and relationships with limited partners, as well as managing liquidity and ensuring robust business continuity arrangements in an environment he said is quickly becoming the "new normal."

"Our role as PE attorneys is to help advise clients on those issues and to help best position them to take advantage of the opportunities that will come out of this global pandemic," Gilman said.

Here, Law360 explores the effects of the global outbreak of COVID-19 on PE practices across the United States.

Many Portfolio Companies Are Struggling

The social distancing measures being taken across the U.S. have significantly impacted many private equity portfolio companies, and how to deal with the fallout is among the top priorities for PE clients.

Fund managers, like all other types of business owners, are wondering what to do with employees of companies that are currently struggling. No one wants to terminate employees, but if money isn't coming in, how can a business justify retaining staff? Meanwhile, private equity firms are also acutely aware of the public perception that the PE industry buys businesses, inundates them with debt and rakes in money while the employees are the ones who get hurt.

"When businesses start laying people off, which they'll need to do in order to preserve other jobs, private equity firms will be vilified by politicians," said Brian Richards, a partner at Paul Hastings LLP and chair of the firm's global private equity practice. "People are really trying to do the right thing, though."

For example, in some cases, portfolio companies are mulling whether it would be prudent to make all employees part-time, which would enable everyone to share the burden a little bit. Alternative options being considered are furloughing some employees or evening out compensation across entire companies.

"The theme of this is just uncertainty," Richards said. "Nobody wants people to lose their jobs, but when there's no revenue coming in for the foreseeable future, and with the government having effectively shut down the economy, it just seems unsustainable."

Fund Terms Are Being Tweaked, and Raising New Funds Will Be Tough

Some fund manager clients may be asking attorneys how they can extend the terms of a particular fund if it appears as though it's going to near the end of its life cycle while everyone is still homebound. There are multiple options to do so, including getting waivers from limited partners to allow for an extended fund term.

"There are lots of different provisions in fund documents where you can either get waivers from LPs, or you can do in-kind distribution where you distribute out the stock of a portfolio company," said Jason Freedman, a partner at Ropes & Gray LLP.

Meanwhile, fundraising has not stopped, but it could become increasingly difficult. Jonathan Adler, a corporate partner at Debevoise & Plimpton LLP in the firm's investment management group, said that among the fundraising challenges are that some LPs want to scale back the dollar amounts of their commitments.

"One thing [general partners] are pretty clearly looking to shift towards are rolling closings," Adler said.

There, instead of the normal schedule of holding a closing for a fund every few months, fund managers are holding closings of sorts on a rolling basis as limited partner commitments come in.

"That makes things a little easier, logistically, for investors," Adler said.

When it comes to raising standard buyout funds, some of the larger, brand-name PE clients will have an easier time than their less established or new counterparts, according to Gilman.

"In the short term, I think it will be extremely difficult for a new sponsor to get to market in the current environment with a new fund if it has not already started on that road," he said. "For example, restrictions on travel and in-person meetings will make LP diligence more difficult and essentially eliminate the traditional investor roadshow."

Deals Are Happening, but New Questions Are Being Raised

The status of private equity dealmaking is much like the state of the market for mergers and acquisitions more generally, according to Freedman: If a deal was already signed before the societal shutdown, it has a good chance of going through, but transactions at other stages are getting put on ice.

"We're certainly seeing deals that weren't right up against the finish line being pulled or postponed," Freedman said, speaking from the Bay Area, which was one of the first places in the U.S. to receive a shelter-in-place order.

There are multiple reasons, including questions about whether debt financing will be available and differences in price now that the stock market is in complete disarray.

"There's a divergence in sellers' expectations versus buyers' expectations on price," Freedman said.

Although many deals are being postponed or even pulled entirely, not every client is simply stopping any deal dead in its tracks. Some are seeking ways to stretch out the process to see how things evolve and more closely examine the effect of the last few weeks, including by asking additional questions and inserting new provisions into agreements, according to Rahul Patel, a partner at King & Spalding LLP and co-chair of the firm's global private equity and mergers and acquisitions practice.

"In some cases, where diligence was nearly completed, clients are reopening diligence by asking additional questions," he said. "The types of questions are evolving and getting more detailed every day."

They include inquiries on the effects of the virus on revenue and earnings at a target and on working capital and working capital targets, as well as the state of a company's employee base and supply chain.

"How is the target company's infrastructure to allow employees to work from home holding up?" Patel asked.

Meanwhile, clients are quickly looking to come up with new representations and warranties covenants to insert into agreements, and are also wondering what all of this means for transactions that require governmental approvals.

Attorneys should be aware that regulators are still very much in business, although they are practicing social distancing just like the rest of the world, according to Keith Townsend, a partner at King & Spalding and leader of the firm's capital markets practice.

"I was on a call with the [U.S. Securities and Exchange Commission] the other day and they had three people on the call, with everyone working remotely and digging in the way they would in an ordinary course of business," Townsend said. "Regulators are doing everything they can to keep the trains running."

When it comes to the deals that aren't getting done right now because of the coronavirus, many are merely getting pushed back, as opposed to being completely nixed, according to Richards.

"Once things go back to normal — we're all assuming that's going to happen at some point — there will be a rush of deals," Richards said. "For law firms, investment banks, accounting firms and everybody in the deal business, the hope is that there's enough time left in 2020 to catch up. I don't think we will in full, but if we can get back to 70% of the deal volume with some deals being pushed to 2021, that would be a good outcome."

Certain PE Clients Are Hungry to Capitalize

No one was specifically prepared for the coronavirus outbreak, but there are private equity clients that feel they are in a strong position to capitalize on the current state of the market.

"There are huge pools of capital out there that have been raised waiting for just this moment," said Jeff Ross, a partner at Debevoise & Plimpton and chair of the firm's finance group and a member of its private equity group.

Ross pointed to vehicle types including distressed debt, direct lending and alternative lending funds.

"Those funds stand ready to lend into difficult situations, but those terms are going to be onerous," he said. "And they are going to be looking for priority on good assets."

In particular, private credit funds are being viewed as a solid alternative to traditional banks when it comes to deal financing, according to Todd Holleman, a partner at King & Spalding and leader of the firm's corporate, finance and investments practice group. He said that such funds can come in and provide one-stop-shop solutions in which terms are certain.

"We're seeing more people talking to private debt providers," he said, adding that in some cases clients are turning to those alternative debt providers for deals that were already in progress and had originally been using normal forms of financing.

"I think it's a market choice," he said. "People are looking for certainty as the credit markets freeze up because they are worried about syndicated options funding and closing on the terms they originally provided in their term sheets. When people are looking for certainty on their deals, that's one of the primary things they are considering."

Meanwhile, some private equity clients are looking at the public markets and gauging whether there might be reasonable deals to be had because of the stock market drops in the last few weeks, according to Richards. Still, there's risk in trying to buy a publicly traded company right now, he said, because the market could go up or down significantly on a daily basis. If it goes up, there won't be a lot of sellers willing to meet a client's price, and if it goes down, the premium a client is willing to offer today might look too rich tomorrow.

"Absolutely though, there are a lot of people spending this time looking at all the public companies and saying, 'Okay, what's the right value, is there a price I'd be willing to pay?'" Richards said.

Even if some private equity firms feel now is not a good time to do deals, many will want legal assistance in preparing so that they can be ready to rock once the coronavirus outbreak is under control.

"Once this stabilizes, there will be some opportunities out there for people who have liquidity and want to be offensive," Patel said.

--Editing by Brian Baresch.

This is part two of a two-part series on how the coronavirus pandemic is affecting M&A and private equity legal practices.

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