The effects of COVID-19 are reverberating throughout the private equity industry. According to the Thomson Reuters Private Equity Index, the performance of portfolios dipped in March 2020 to levels not seen since March 2016.  Research further suggests that portfolio valuations may be down by as much as 31% in Europe and 35% in the US as a result of the virus.  With fewer sale processes (read more here) also creating fewer opportunities to utilise dry powder, investors are understandably looking to protect the value of their existing portfolios.

While there exists a common interest between investors and management teams to protect value in these circumstances, opinions may diverge on the best way forward. Most decisions in response to the pandemic will be taken at board level.  Investors often negotiate the right to appoint directors to boards.  But such directors generally comprise a minority where the majority rules.  So how might an investor seek to counteract this?

An investor wishing to play a proactive role could look to use so-called 'swamping' rights conferring control of the board when exercised.  Such rights are normally exercisable during periods of underperformance or projected underperformance but could be structured to become exercisable, for example, during pandemics or other emergencies. Veto rights offer a more passive layer of protection and prevent a company from carrying out a specified action without an investor's prior consent. Such rights are normally structured to apply at all times but could be dynamic and become more prescriptive in certain circumstances. However, these protections need to be used with care, as they can damage relationships between investors and managers.  Consensus is usually best, if achievable. 

It will be interesting to see how investors respond to the challenges caused by COVID-19, both now and when negotiating future investments. 

Written by Isaac Paine.