In a previous post, we discussed the impact of COVID-19 on private equity transactions and how companies can prepare for upcoming economic changes. While opportunities for new investment are on the horizon with private equity funds presently flush with cash, movement on existing investments is likely to slow as sellers wait until markets stabilize before divesting their assets. Recent research suggests that funds with vintage years 2012 through 2017 are facing a lower exit pricing environment, which could lead fund managers to increase their holding periods and delay exiting until they can better recover their investments.
A look at the past offers insight into what the impact of COVID-19 might look like. The EY Global PE Watch 2018 report states that 2008 held a low point in average holding periods in the past decade, with averages increasing among private equity-backed portfolio companies for several years following the 2008 Recession. This occurred largely as a result of a sharp decline in M&A activity and the IPO market, and subsequently caused a push for private equity firms to add operational teams within portfolio companies to create greater value while the assets were held. The McKinsey Global Private Markets Review 2019 similarly discusses prolonged holding periods following the 2008 crisis, with many firms only recently selling off their pre-crisis assets. A review conducted in 2019 saw exit count and holding periods finally returning to pre-crisis levels between 2017 and 2018, as the result of add-on investments consolidating the number of exits over time and pre-crisis assets finally being wound off and sold. As a result, the sale of private equity-backed company shares held for more than eight years declined from 22 percent in 2015 to 16 percent in 2018.
COVID-19 is likely to have an similar effect on exits and holding periods, with sellers delaying until the markets recover and increasing their holding periods once more. However, there may be less of a long-term impact stemming from COVID-19 than the 2008 Recession. In a recent brief published by Bain & Company, the authors suggest that unlike 2008 and 2009, when many private equity portfolios were around two years old, general partners are currently holding a more mature group of assets that would typically be gearing up for sale in a normal market. So while portfolio companies will be held until market conditions improve, exits may bounce back faster than they did in the past. Still, as we learned from the 2008 crisis, private equity firms should focus their energy towards creating value within their existing companies and hold off on pushing forward with an exit too quickly (for a refresher on private equity exit strategies, please see the following post). The high levels of cash on hand offers a cushion allowing firms to wait for an opportune time and respond quickly to the right opportunity.
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