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Cautious Optimism Prevails: Duane Morris Hosts Private Equity Forum in Boston

Staff Writer
October 9, 2009
Duane Morris LLP

As the economic crisis eases, some private equity analysts are hopeful that investors who have remained on the sidelines will get back in the game. This sentiment was echoed by panelists during the Duane Morris Private Equity Executives Forum, held on September 24, 2009, in Boston. George Donnelly, editor of the Boston Business Journal, served as moderator of the program.

"I'm cautiously optimistic, but I'm looking in the rear-view mirror at what is coming after us," said Bruce R. Evans, managing director at Summit Partners, a private equity and venture capital firm with $11 billion under management. Evans participated in the conference, along with Martin B. Shulkin of Duane Morris LLP, Michael R. Bailey of HighVista Strategies and Lane MacDonald of Harvard Management.

The long-term impact of the highly leveraged deals completed from 2005 to 2007, manifested by so-called covenant-light loans, is prompting caution among fund managers and many investors to conserve capital. The bottom line guiding the present-day actions of many in private equity is the knowledge that investors are going to be particularly careful not to send good money after bad when faced with a decision of providing additional equity capital to either "pay off" or "purchase" these covenant-light loans when they mature in 2012-2013. This expectation is putting additional operational pressure on fund managers to preserve cash, and increase performance of the portfolio companies.

Add that to the credit contraction and bank consolidations and failures, and the result is a continued restraint on credit, said Shulkin, a senior partner and manager of the Boston office of Duane Morris LLP, a 700-lawyer international law firm. Shulkin's practice is concentrated in corporate deals, mergers and acquisitions.

"Obviously it's a slow recovery," Shulkin said. The deal flow has not resumed, which is a reason the industry anticipates further consolidation and contraction.

"No one has seen the banks come rushing back," he added. "Banks are lending to each other, and the financial terms being offered on transactions are much more demanding." Nevertheless, he maintained that glimmers of hope are popping up.

"We're starting to see more exploration of deals," said Shulkin. But the ones that are getting done tend not to rely on banks for funding, or have much greater equity requirements, and are coming in at much lower valuations, he said.

The upside, however, is that pricing is becoming more realistic, according to Evans.

"Now that the market has gone back up and prices are lower-certainly for leveraged transactions-entrepreneurs are becoming more realistic about price," he said. "It's now harder to sell a poor performer." Summit is scrutinizing opportunities in India and China and trying to understand the less-developed management structure of companies there, along with less-developed securities laws, tax issues and less certainty concerning government policy.

Some on the panel expressed that it is difficult to analyze the current landscape without considering the dark clouds on the horizon caused by the covenant-light loans issued in the easy lending days of 2006 and 2007. Most of the default-proof loans made with scant equity are slated to mature in 2012 and 2013. Until then, the banks that made them in hopes that values would keep rising are locked in to them.

The lasting effect of these trends is a longer "exit" time line, predicted Bailey, who focuses on private investments at HighVista Strategies, a Boston-based investment firm that manages more than $2.3 billion on behalf of families, endowments and foundations.

"The economic slowdown and weaker capital markets may add two to three years to private equity illiquidity," said Bailey. In 2005, 2006 and 2007, buyers were buzzing around the private markets.

"One of the positives is that many of the more speculative buyers have exited," he said. It is likely to be a good thing for the industry to have a more realistic pricing structure prevail.

Bailey is also focused on identifying the top-performing fund managers, who, in turn, are keen on companies that can take advantage of the economic uncertainty.

"We have shifted our focus to looking for dislocated markets and good relative value," said Bailey.

For more information on the conference or on private equity legal matters generally, please contact Martin Shulkin at 857.488.4210 or visit the Corporate Practice Group page on the Duane Morris website.

About Duane Morris LLP

Duane Morris LLP, a full-service law firm with more than 700 attorneys in 24 offices in the United States and internationally, offers innovative solutions to the legal and business challenges presented by today's evolving global markets. Our Corporate Practice Group provides practical and creative legal counsel, while assisting clients in complying with regulatory, statutory and other legal mandates. Our long history in the private equity and venture capital markets gives our attorneys the knowledge to guide clients from a legal perspective and the experience to analyze the most-effective business strategies at every stage of their growth. Our attorneys assist private equity funds, investment banks, financial institutions and individual investors with structuring and consummating private debt or equity investments. We also help private equity fund clients and management boards initiate, structure and complete leveraged buyout offers to take companies private.