There have been a number of significant developments across capital and financial markets in recent weeks, many of which have been directly or indirectly related to the ongoing impact of COVID-19, otherwise known as Coronavirus. As I am sure readers will be acutely aware, following the unprecedented sell-off across financial markets, there have been a number of both fiscal and monetary policies put in place to provide the necessary support to the economy. Much of this support has been focused toward many of the smaller businesses which will come under strain, and many current and future investors are left to wonder how future developments will impact deployment rates, valuations, and exit opportunities within the tax-advantaged market. Further, it cannot go unmentioned that recent events have transpired as funds within this space prepare for an increase in fundraising in the month leading up to the April tax year end. Below, the team here at MJ Hudson have outlined some key considerations in the current environment.
Broader Market Implications
During periods of market volatility, there is evidence to suggest that that investors take a “relative flight to quality”, rotating toward the perceived stability of traditional safe havens such as sovereign debt markets. However, even demand for these instruments has been tempered by concerns surrounding massive stimulus packages announced by many governments. Nonetheless, it does raise some concerns about the impact that this may have on the availability of funding for investments placing higher on the risk spectrum, such as companies that would qualify for VCT or EIS/SEIS relief.
It should also be mentioned that as many EIS and VCT portfolio companies will work toward an exit via trade sales, struggles within broader industries may also create pressure either on valuations or on acquisition timelines, which may delay realisations across fund portfolios. In addition to this, start-ups may struggle with an increase in absentees, alongside heightened use of benefit packages, such as healthcare or sick leave, which will put a strain on companies’ available liquidity. Underlying investee companies with strong balance sheets, and investors with deep pockets and who believe in the longer-term growth story, may fair better than others. Nonetheless, as these broader market pressures come to the fore, it may ultimately have an impact on company valuations, and the ability for managers to deploy into quality investee companies.
Supply Chain Disruption
General supply chain disruption, specifically within technology companies which rely on components provided by foreign vendors, may create situations where investee companies struggle to source the necessary inputs required for their products. When this is accompanied by a lack of diversification in revenue streams, for example companies with an individual product or end market, they may be faced with the prospect of having to absorb losses, as parts become scarce or increase in price. At this stage, the development of contingency plans and constant communication between portfolio companies and the investment manager is essential, so that the former benefit from the shared knowledge that the manager has access to.
Leisure & Hospitality Sectors
Certain industries will be affected disproportionately by the outbreak. Government measures regarding the closure of venues, bars and restaurants are already causing hardship to the leisure and hospitality industries. Although there is no definitive clarity on the timelines imposed by the UK government on closures, we would expect many companies operating within these sectors to encounter some cash flow issues, with those that have taken on debt or are at the earliest stages of development likely to be affected to a higher degree. Companies will have to work closely with managers in order to establish the best course of action, which may involve targeting significant fixed costs, such as staff and property, with the end goal of lowering costs and increasing cash positions.
There is also a commitment from the Government to mitigate costs in this area, which comes in the form of a full Business Rates Relief applicable to businesses operating within the retail, hospitality, and leisure sectors, a measure which intends to lessen the damage caused by closures by decreasing the overall cost-base of the relevant businesses. Although it is unclear to what extent this will help mitigate a prolonged loss of earnings, given that tentative models created by Imperial College, on commission from the Government, suggest that the proposed measures need to be sustained for several months in order to have the desired impact, suppressing consumer spending further.
On the other hand, the increase in fundraising volumes in recent years may be seen as having created a moat which should put some managers in a good position to support ongoing businesses, although managers must do away with the ever temptation of pursuing companies which are likely to fail.
The new Coronavirus Business Interruption Loan Scheme (“CBILS”), which was announced at Budget 2020, attempts to offer some support for companies struggling to obtain credit during the coming period. On releasing final details of the CBILS, Government has made it clear that all EIS and SEIS funded companies will qualify for the scheme. However, some would argue that it falls short of providing the necessary support to a large portion of the EIS/SEIS investment community, as it can be time consuming process, through which companies must apply through the traditional banking routes and satisfy an eligibility test which may prove unduly onerous in circumstances when applicant companies’ revenue projections are expected to falter over a longer period. In addition, there is a concern that, since borrowers remain fully liable for the debt under the scheme, this may create further strain on companies later in their cycle. Therefore, in order to be fully effective, measures taken will need to bolster equity investment made alongside the CBILS.
It would be fair to say that this has been a less than normal run-up to the tax-year end. With the potential for slower fundraising, it could arguably create an environment where deployment will become more selective than ever. Now more than ever, managers who employ a hands-on approach in managing investee companies and have a deep understanding of their businesses’ mechanics will be able to demonstrate their value-add to both their portfolio of investee companies, and ultimately to the investor. Much hope is placed on Government’s support, however given the situation which provides an abundance of distractions for authorities, investors must be prudent in placing heavy reliance on Whitehall to deliver further relief in this area.
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