The COVID-19 pandemic required extraordinary steps by private equity general partners (GPs) for their portfolio companies to weather the storm and survive. Such steps have included drawing down revolvers to preserve liquidity, cash burn reductions and reconfiguring, and, in some cases, even mothballing operations. The value impact of such specific measures may be difficult to quantify. However, as limited partners (LPs) seek to evaluate performance over the life of an investment, it is essential for GPs to demonstrate that what they do to create value has preserved value for their investors over the course of the pandemic.
Demonstrating the ability to create and preserve value is both a qualitative and quantitative effort. It involves documenting, over the holding periods of the portfolio company investments, the initiatives taken, before, during and after the current crisis that have built better businesses and created value for investors. And key to quantitatively measuring value creation and value preservation is benchmarking portfolio company performance against an appropriate measure of industry and sector performance.
The COVID-19 crisis has clearly impacted values and will no doubt impact returns, and performance and returns now vary more widely across industries. In this environment, benchmarking is even more critical to identify and measure value preservation. Just as a rising tide may obscure outperformance, or underperformance, industry and market headwinds can mask value preservation. As the current volatility has heightened concerns of future down markets, the ability to quantify operational and strategic value-add and value preservation assumes new significance.
While COVID-19 impacts have been overall negative, the meager or even negative returns that may have resulted do not mean that GPs have not preserved value. In these situations, a GP’s value-add offsets negative macro impacts not under their control. We have seen this time and again in our value attribution studies where alpha, as a source of value creation, becomes a source of value preservation, indicating that without the contributions of the GP, performance would have been worse.
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