Who’s Looking Out For Private Equity Limited?
The past couple of weeks have seen the Government announce a volley of financial support packages for businesses. The two direct support programmes that have already launched, the Covid Corporate Financing Facility (CCFF) and the Coronavirus Business Interruption Loan Scheme (CBILS) have met with some criticism, notably that CBILS support is not reaching enough of corporate Britain fast enough.
The Government responded on Thursday by loosening the eligibility criteria for CBILS and immediately opening it to small businesses who have sufficient security headroom. Alongside that, was an announcement that CBILS would soon be joined by a bigger cousin, the Coronavirus Large Business Interruption Loan Scheme (CLBILS). This scheme will be targeted at businesses with annual turnover between £45 million (the maximum threshold for CBILS eligibility) and £500 million (a level approaching the claimant constituency for the CCFF). So CLBILS answers the market demand for a scheme to cover the neglected mid-tier, and in doing so makes such direct government support potentially far more relevant to private equity. So does this new scheme plug the last remaining gap?
More than 3,400 businesses in the UK are owned by private equity. Between them, these portfolio companies employ more than 800,000 people and play an integral role in the UK economy. If private equity were a single business it would be the UK’s second largest employer, smaller only than our beloved NHS. Yet, as matters stand, it’s not at all clear that this trio of direct financing support schemes will offer just that for many of those 3,400+ companies.
Only a tiny handful of portfolio companies will be eligible for the CCFF scheme. By definition, most will not be investment grade. It may also be a challenge to accommodate commercial paper (CP) within the capital structure of these businesses. The eligibility criteria suggest that the CP would need to share in the security granted to the existing creditors, and that would likely require their consent. If the price of that consent is that the CP is subordinated, it will not be eligible to benefit from the CCFF.
This leaves any portfolio companies seeking Government support looking to the CBILS or, once launched, the CLBILS. Of course, there won’t be any problem with their lack of an investment grade rating with these schemes. But consent issues with existing creditors may still remain as any loan will need to find its place in the capital structure, particularly if additional indebtedness baskets are insufficient. This may, of course, be true for businesses not backed by private equity. But the capital structures around portfolio companies, coupled with the tighter, leveraged credit, terms are likely to add an additional layer of complexity.
There’s a more generic challenge. Although we don’t yet know the detailed criteria that will apply to the CLBILS, some accredited lenders under CBILS are currently applying a working assumption that revenue of private equity portfolio companies is to be aggregated with all other portfolio companies under common ownership and control when assessing whether the applicant business has annual turnover within the £45 million limit. As a result, all but a tiny minority of portfolio companies will find themselves ineligible for CBILS support. If, as expected, the CLBILS criteria track those for CBILS then we can expect the same approach to apply there, albeit the larger turnover threshold would accommodate more portfolio companies.
By aggregating at this level, this effectively characterises all portfolio companies owned and/or controlled by a sponsor as a single group, thus positioning it in the same way as a sponsor-less consolidated corporate business. Guidance for CBILS issued by the British Business Bank confirms that “if your business is part of a group, controlled on either a legal or de facto basis, the maximum turnover applies to the group undertaking. More than one company within the group can be considered for a CBILS facility but only if the consolidated group turnover does not exceed the £45 million annual turnover threshold”. If the same guidance does apply for CLBILS then, contrary to what might be expected, it would be possible for more than one portfolio company to apply for CLBILS support if the “group” were eligible, although it’s not clear whether the total amount of funding to the group would be capped at the scheme’s loan limit of £25million.
There are echoes in all this of the treatment of smaller private equity portfolio companies under the “Paycheck Protection Program” in the US Coronavirus Aid, Relief, and Economic Security Act (CARES Act). That legislation, like CBILS, is targeted at small businesses. It respects, with limited exceptions, the Small Business Administration “Affiliation Rules”. Employee numbers are thus aggregated across “affiliated” portfolio companies. This has had the effect of rendering many such companies ineligible for support under the Program. In the US there is a lobbying effort underway to change this.
Meanwhile, here in the UK, the aggregation risk is real for sponsors. This would be consistent with the “we’re all in this together” approach that underpins Government thinking. Indeed, several Ministers have commented that sponsor support is one of the areas that companies should look to. Some accredited lenders may interpret this as confirming that the “needs-based” approach underpinning the CBILS programme – portfolio companies’ have an alternative: their owner. If the Government does more readily accommodate portfolio companies, the decision to apply for support may not be neutral. Sponsors will need to consider what engaging in the scheme might entail. There may well be strings attached to any funding, with conditions on aspects such as distributions and management remuneration.
The position on this side of the Atlantic also needs to be clarified quickly, Private Equity Limited is too big to ignore.