May 13, 2020

Private Equity: PE Fund Reputational Worries Shift in the Covid-19 Era

Private equity deals often involve a lot of contingencies, and the fund’s financial downside is usually limited to some kind of reverse breakup fee. In these situations, PE funds have traditionally reassured sellers that walking away from a deal would damage the fund’s reputation & ability to do future deals. This Axios article says that may have been true in the past, but in the Covid-19 era, not walking away from a deal may do more damage to a PE fund’s reputation:

Private equity investors have historically taken a dim view of peers that renege on signed merger agreements, believing that an honorable reputationcan be the difference between winning and losing the next deal or next fund. What’s new: Not only have stigma worries dissipated, but some buyers now feel honoring their pre-pandemic word would diminish their reputation.

Driving the news: Broken buyouts are becoming nearly as prevalent as new ones. Just within the past 48 hours, we’ve learned that: Carlyle bailed on its $900 million deal for a 20% stake in American Express Global Business Travel. Kohlberg & Co. walked away from its $550 million deal for cake decorations company Decopac, owned by Snow Phipps.

It’s one thing to buy a company that eventually loses value,” says a private equity investor whose firm is largely sitting on the sidelines. “It’s quite another to buy a company that you need to write down by 50% the minute you close. That’s a tougher sell to limited partners.”

So, when push comes to shove, it looks like some PE funds have decided that it’s better to risk reputational damage with sellers (and a lawsuit) than to risk reputational damage with their investors. On the other hand, maybe they just figure that anybody that’s a seller in this environment needs PE buyers too much to worry about whether their buyer tried to get out of pre-Covid-19 deals.

John Jenkins