GPs turn to preferred equity in hunt for emergency liquidity

As cash reserves run empty, private equity firms are focusing hard on emergency liquidity for their portfolio companies. Most will have drawn down on overdrafts or revolving capital facilities, and those in eligible sectors will be trying to tap into government rescue funding. But many will also be seeking an additional buffer for their assets as they try to wrap their arms around the unknown future.

"GPs are wondering how they should build up their war chest and how to raise pots of capital fast," says Kate Downey, head of the European private equity funds practice at Fried Frank. "Those that can will raise portfolio leverage. But this can be hard as you need to look at anticipated cashflow, and right now revenues are depressed so this additional debt isn't open to everyone."

Private equity owners Cinven, EQT and CPPIB only a few weeks ago injected €400m into portfolio company Hotelbeds. But rather than putting the money in as equity, the facility was put in at the top of the capital structure, ranking pari passu to existing term loans, according to a report by sister publication Debtwire. This was seen as a lifeline for the B2B accommodation provider, showing that the sponsor believes that the business is viable post-pandemic.

In a similar move, Pizza Express secured £70m in new money from direct lender HPS Investment Partners, which got super-seniority in the capital structure so that it is repaid first and has first call on any money coming back. In both cases, existing lenders are seemingly acquiescent, as interests in defending the portfolio companies are aligned.

"GPs are rigorously looking at all their portfolio companies at the moment and there will definitely be a divergence between companies deemed worth backing and those that are not," says one leveraged finance banker. "Private equity houses will look to see if the company was good pre-Covid and still viable after, as they will be gauging whether it is worth injecting fresh funds in order to keep things going or whether it would be a case of putting good money after bad."

More flex at fund level
Since it is unclear what the future holds and when other cash needs might develop, those vehicles that have little or no uncalled capital left might look to raise an additional facility at the fund level.

Indeed, one approach to gaining more flexible liquidity – as developed through the secondaries market and GP-led transactions – is a preferred equity facility at the fund level, says Sam Kay of Travers Smith.

"There has been a noticeable increase in the number of enquiries about these types of transactions," says Kay. "The benefit of a preferred equity structure is that it can be implemented relatively quickly and it does not necessarily require LP involvement or consent. It also means that the fund retains the upside after the preferred equity instrument has been repaid."

In a sense, the facility acts as a blind pool of capital that can be used for any company in the portfolio, as opposed to being specifically earmarked for one asset.

A facility based on NAV – secured against the underlying assets in the portfolio – is also an option, though it is still considered leverage, and, while less expensive than the hefty 12-14% cost of preferred equity, may take longer to put in place, as well as being potentially more restrictive. Preferred equity on the other hand has the advantage for the user of only obliging payouts when there is actual cashflow from a company, and typically there is not a quarterly or half yearly mandatory payment schedule. Both sit roughly in the same place in the structure of the vehicle – below existing debt and above LP equity.

"The big sales pitch of preferred equity to GPs is that it is usually unfettered by restrictions on the ability of the GP to deal with its portfolio. It generally relies on a contractual entitlement to cashflow from a fund's underlying portfolio companies," says Downey.

Preferred equity has been on the fund landscape for some time and specialist providers such as 17 Capital and Whitehorse Liquidity Partners have been very successful in building a business model around this type of funding. Whitehorse closed Fund III in October last year on its $2bn hard-cap and 17 Capital is reportedly in the process of raising its fifth fund for the strategy, with a target of €1.8bn.

17 Capital founding partner Pierre-Antoine de Selancy says his firm has been inundated with queries for preferred equity, with enquiries totalling $3bn in the last three weeks alone – with 90% coming from GPs. This is compared to $10bn for the 12 months to the end of 2019, which consisted of a more diverse range of clients (GPs, LPs and family offices).

"Banks have been providing NAV for a long time, as well as capital-call facilities, but they will struggle to provide something that doesn't have a maturity schedule and only has cashflow from companies coming back. Preferred equity is very flexible as you can use it for 20 companies or tailor it to just five or six in the portfolio," says de Selancy.

A downside, apart from the cost, is that LPs might struggle with another quasi-equity provider ranking ahead of them and getting first dibs on returns as cash comes back from exited portfolio companies. But in the current environment, when liquidity is key, interests will likely be aligned with the first priority of all stakeholders being to fiercely protect and support the underlying companies.

"You're only going to raise preferred equity if a fund is fully called and you need access to liquidity. It needs to make sense and it is usually to defend your portfolio, so at that point LPs will be on board," says de Selancy.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Financing
• Funds
• Exclusive
• coronavirus
• 17Capital
• Fund financing