Updated: Mar 23, 2021
Global economic uncertainty is at its highest level since the 07-08 financial crisis, and many investors have been forced to pause deal-making activities. In Q1 2020, the number of US PE deal-making activities rose YoY, mostly driven by deals negotiated before COVID-19 hit. Exit value recorded a steep decline, as GPs chose to hold on to portfolio companies until the economy stabilizes. US PE fundraising also experienced declines, as LPs shifted focus to funding current capital calls and portfolio rebalancing. As we enter Q2 and Q3, the current dearth in announced deals and the ramification of the pandemic will become more evident.
Impact on the Private Equity Industry
Deal-making – GPs focus on keeping current portfolio afloat: PE firms are now in a triage mode, deciding which portfolio companies to save and which to let fail. Large-scale transactions have been paused or canceled, and we can only expect a few in the forms of private investment in public equities (PIPEs), growth equity deals, or carveouts. First, PIPEs are attractive to PE firms because the valuation volatility has made public firms more lucrative to takeover than private firms. Second, smaller deals and add-ons offer an attractive way for GPs to spend capital at a depressed price. Smaller deals typically receive funding from private lending funds with mountains of dry powder, compared to massive deals that need to receive funding from bank syndicated loans, which are hard to obtain at this time. Third, additional deal flow will come from conglomerates seeking carveout or divestiture of underperforming departments in exchange for cash.
Exit – GPs will be more likely to hold on to portfolio companies than sell at a discounted price: following the global financial crisis, median US PE holding times increased from 3.7 years to 6.2 years between 2009 and 2014 as GPs take extra time to turn portfolio companies around and exit in an amenable environment . On the sellers’ end, GPs loathe seeing years of growth disappear in weeks. With volatility spiking to the highest record, IPOs are no longer an option. On the buyers’ side, sponsor-to-sponsor transactions are likely to dribble as GPs slowed their pace. Strategics are also pausing as it becomes impossible to conduct due diligence via video conferencing. Though the overall exit opportunities appear pessimistic, lower-middle-market GPs are likely to have more success exits than counterparts because their portfolio companies are usually below a couple hundred million dollars. Such scale makes portfolio companies attractive targets for smaller deals or adds-ons, which are alternative ways of deal-making amid this pandemic.
Fundraising – Multi-billion funds are expected to find continued success: mega-fund managers are in the best position in 2020 because of their established LP base. Fresh fundraising for middle-market GPs will prove difficult as LPs become conservative over the global crisis. For first-time fund and nascent managers without an established LP, fundraising is almost an impossible task. LPs are putting their energy towards assessing their current portfolio rather than committing to new holdings. The denominator effect complicates the situation – a decline in the value of one asset should result in other assets being sold to properly rebalance a portfolio – which further reduces LPs’ investment incentives. Thus, only firms with established LPs or GPs bringing back strategies that LPs had invested before will likely raise funds.
Healthcare: Recession-Resilient Sector
This crisis will further pique GPs’ interest in long-term growth and recession-resilient sectors. With 20.2 million private-sector jobs being cut and discretionary consumer spending decreasing sharply, healthcare spending is likely to be the long-term winner due to this crisis. It is the most recession-proof because companies in the sector continue to operate despite the global turmoil, and the demands for them stay inelastic. Although healthcare only accounts for 6.8% of the deal value in Q1 2020, the proportion will pick up throughout the year as other sectors take time to recover . Also, as pharmaceutical companies racing in the vaccine marathon for COVID-19, the successful launch of a vaccine can be another stimulus for the industry.
Challenging, yet Promising
With our position as a lower-middle-market GP and a focus on late-stage venture-backed healthcare companies, we here at Bridge Point Capital are ready to capture investment opportunities and success exits in this evolving landscape. Our current portfolio of tech-savvy healthcare firms benefits from being in both the technology and healthcare industries, the top two recession-resilient industries. The comprehensive and creative value-creation strategy also ensures our long-term success in the full private equity investment process – from deal-sourcing to exit.
 Pitchbook: COVID-19's Influence on the US PE Market, pg.5
 Pitchbook: US PE Breakdown, pg.6