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Coronavirus - Private Equity and the pandemic: Preparing for the future - Global

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  • Coronavirus - M and A issues
  • Coronavirus - Tax issues
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Our series of articles on private equity and the pandemic now turns to the future and our thoughts on the some of the changes, opportunities and challenges for the industry post-pandemic. Although, perhaps it would be more accurate to say “intra-pandemic” since it seems clear we are very much still in the middle of the storm and will likely continue to be so until a proven vaccine is widely available. Nonetheless, all around me in my professional and private life there is a tangible shift from coping with the “now” to planning for the future (neatly encapsulated for me by my kids counting down the days of the summer holidays in excitement for the return to school – I’ve never seen that before!).

My kids’ desire to return to school parallels the most immediate future consideration for all businesses – the return to the office. It is fair to say that there are a more diverse range of views on this issue from those that I speak with than the return to school (although my survey group of two pre-teen girls and any of their friends who come over for a playdate is perhaps not representative). However, although the risks and challenges are significant and not to be taken lightly, there does seem to be a general desire to return to the office. In most case this does not stem from a desire for the physical office environment – most people have adapted well to remote working, have created comfortable home working environments and have replaced commuting with a better use of time. The strong draw back to the office comes more from to the personal interaction we have all lost in this lockdown period – as Richard Kyle said in his kick-off article for this series, it’s the “camaraderie of the office and being able to meet with clients and colleagues” that we are all missing.

From a personal perspective, this is certainly true. I can hardly claim to have had a difficult lockdown – in my pre-covid life I was commuting to London on a Monday, staying all week then returning to my family at the weekend. Lockdown ended that slog and gave me the opportunity to be a more present father and husband and to participate more in family life. It has also helped that my home is near Lisbon in Portugal – not a bad place to be locked down, frankly! However, I still find myself looking forward to the return to the office and a working environment with more personal interaction.

I have however been questioning this desire closely, given that the return to the office for me will mean less family time and the risks of air travel and London commuting. Am I just seeking the old, familiar comfort blanket of the office, or is it something more? My conclusion is that I can do almost every aspect of my job that little bit better through direct human contact and I am not content to compromise on that. This may surprise those who have flicked down to my job description at the bottom of this article – however, contrary to common belief, tax lawyers should not be kept in a darkened basement and only consulted at 11pm on the night of completion when that last tax issue that everyone has previously ignored just won’t go away!

Joking aside, working in a close-knit, integrated cross-practice team is at the core of the way we operate at Eversheds Sutherland and personal interaction is vital. As a tax lawyer, I frequently find myself explaining issues that are not always easy to grasp or that do not always hold the interest of the listener (and often both!), In person you can see from the body language when the message is getting through and adapt your approach - this is much harder remotely. This is equally the case with the training and development of the more junior members of my team - Zoom, Teams, Skype and the rest still have a long way to go replace physically sitting in a room and talking through a point or the learning through osmosis that inevitably occurs in an office environment. And then I come back to possibly the most important point – the camaraderie of the office environment, the non-work conversations, banter, gossip, the shared pain of the difficult deal or working into the night. All of this improves a normal working day, but perhaps more importantly builds relationships, friendships, trust and ultimately creates more effective teams. Through the challenging initial lockdown period, I’ve seen the power of these relationships developed by my team pre-COVID and businesses will need to find ways to continue to develop these relationships in the intra- and post-pandemic world.

However, the challenges of returning to the office are significant and for most it is likely to be tentative baby-steps over the next couple of months, assuming no second wave. Further, for the private equity industry, this very immediate issue is a microcosm of a key concern for every portfolio investment – when can these businesses return to their premises, are staff adequately protected, should there be a return to a physical working environment, should these businesses have the same real estate footprint in this new environment, are existing IT systems adequate to support a more sustained remote working environment going forward? These are core issues that all businesses are looking at right now, but areas where private equity-backed businesses are likely to have the best skills, flexibility and resources to effect change and adapt business models for the future.

Returning to the office and the future office environment is just one of the issues facing the private equity industry in the coming weeks and months. In the next articles of this series, my expert colleagues will give their views on the following important issues for the industry:

The future of M&A

Ceri-Ann McGraa, Paul Pugh and Chris Archer will share their views on the future of M&A in the private equity industry, considering the impact of the pandemic on value and pricing, the potential for longer investment holdings periods with the opportunities and challenges that presents, the importance of deal origination to take advantage of this period of disruption, opportunistic M&A (both new investments and bolt-ons) and the impact of all of the above on M&A processes.

The future of debt financing

Following on from his earlier article on debt finance trends in the initial stages of the pandemic Chris Hastings will, as he says, dust off his crystal ball and share his thoughts on the future of debt financing. Chris has gathered input from different players in the debt market, so will endeavour to distill those views to give a wider take on the next steps for debt finance.

The future of management incentivisation

Danny Blum will share his views on how the pandemic could influence management incentivisation in the future, including the impact of the pandemic on performance targets in existing incentivisation arrangements, the opportunities potentially lower valuations or higher debt burdens present for implementing new incentivisation packages and the structure of effective management incentivisation going forward.

Restructuring considerations

Finally, Ceri-Ann McGraa will give some further thought to restructuring issues. Our earlier articles touched upon a number of the immediate actions PE sponsors and their portfolio companies were taking to survive the early pandemic period, but Ceri-Ann will now look forward at more significant restructuring activity such as redundancies, debt restructuring and accelerated M&A processes, highlighting both the challenges but also the opportunities these actions present.

Finally, as a tax lawyer I am afraid I cannot leave you without commenting on the future of tax in the intra- and post-pandemic world, particularly since for the private equity industry the impacts of future change could be significant. I should however start by noting that, as discussed by my colleague Colin Askew, tax and tax policy has actually had a very positive impact in the initial period of the pandemic, with the tax payment deferrals, lower tax rates for certain sectors and targeted tax exemptions all playing a part in helping businesses through difficult times. Governments should be praised for these quick actions and the much wider fiscal stimulus packages implemented, but the reality is that this will all need to paid for at some point in the future.

The most likely route to replenish emptying government coffers will be tax increases and more aggressive tax enforcement. The options for revenue raising tax changes are wide and I will not be thanked for speaking at length on tax policy in this forum, but for the private equity industry specifically some very impactful near-term changes are on the table. One example is a potential change to capital gains tax, with the possibility of an increase in CGT rates to align these with income tax rates. This will not only directly impact investment managers, but will also have a significant impact on the equity incentivisation model for portfolio company management. A key advantage to equity incentivisation is the lower tax rates associated with selling equity – an equalisation of the CGT and income tax rates would remove this aspect of the incentivisation package for management, reducing the value of that package for many managers by more than 20%. This change could shake up the whole private equity management incentivisation model, driving renegotiations of existing packages and a potential future shift from equity incentivisation to performance bonus based incentivisation.

In addition to potential tax increases and the introduction of new taxes, it is likely that tax authorities globally will become more aggressive in pursuing tax considered due under existing rules or that falls into the grey areas of these rules. What this means for all businesses, including the private equity industry, is a likely increase in tax audits, challenges and disputes, which will take management time and professional fees to address and will give rise to greater complexity with acquisition and sale processes. The increasing prevalence of tax reporting obligations such as DAC6 will only add to this issue.

But enough tax… We are living in a period of change to all aspects of our lives, both professional and personal, and while that is daunting and presents challenges, it is also exciting and presents opportunities. Over the coming weeks, my colleagues will look at these challenges and opportunities, which we consider the private equity industry is almost uniquely positioned to capitalise on. Next week we start with Ceri-Ann McGraa and Paul Pugh on the future of M&A.

Now I’m going to begin my preparations for the return to office by trying to work out if any of my suits or shirts still fit me following my lockdown sedentary and binge eating. Or I might just have a couple of choccie biscuits and watch more of The Last Dance on Netflix instead…