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Unless you’re involved in the sector, it’s unlikely you would have seen much discussion regarding the global COVID-19 pandemic’s impact on the private equity market. To some degree, it’s hardly unsurprising – given how the virus has run rampant across lives and livelihoods, as well as sparking civil unrest and geopolitical tensions. Nevertheless, private equity has not escaped the effects – with firms looking to salvage and minimise the impact on their portfolios, whilst also seeking new opportunities and bets emerging from the disruption caused by COVID-19.

This has led to a range of stances, with some managers pivoting portfolio companies into future growth, while others focus on riding out the storm with cost cuts. Others are “hibernating” those businesses with sufficient reserves by simply handing over the control to banks so they can focus on the future. Regardless of the position, one universal truth about the pandemic is that it is accelerating existing trends, such as the digitization of customer channels and workflows, as well as amplifying the need for low- to zero-touch operational models.

The pandemic is also giving rise to new trends—for instance, a need for real-time tracking and traceability. Other pressing needs include business models that adapt to shifts in consumer preferences, notably a preference for value and essentials; changes in credit; and changes in government regulations and policies, such as trade embargoes, sanctions, and other restrictions.

However, one trend that has been noted in the post-pandemic industry planning has been the rise of ESG. ESG stands for Environmental, Social, and Governance and investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. ESG metrics are not commonly part of mandatory financial reporting, though companies are increasingly making disclosures in their annual report or in a standalone sustainability report.

Traditionally, sustainable investment was confined to a small, dedicated corner of the private equity market. But over the past few years, a combination of factors has meant sustainability is permeating almost every aspect of the private markets. The coronavirus pandemic has intensified discussions about the interconnectedness of sustainability and the financial system. As a result, ESG has become a value driver rather than just a compliance or purely reporting topic, much like how private equity firms have viewed digital and ageing demographics, with customers increasingly shifting to firms that are better placed on the ESG side.

In the post-pandemic world, ESG and sustainability are changing the way that private equity looks at risks and opportunities around a target, with a mindset shift that see ESG risk as important and as central to a company as any other type of financial risk, such as leverage risk. More attention is also being paid to how the management thinks about ESG and whether it is actively trying to measure and improve their company’s ESG credentials. Unsurprisingly, this has impacts on cost structure, capital, talent and more – all of which must be built into plans.

Private equity firms have certainly been applying operational expertise within their portfolios to mitigate ESG risks. Deep sector knowledge and experienced operating partners who have been in the trenches have increased within private equity firms exponentially in the last ten years. Few investors will bring better credentials for how to adjust operations to comply with ESG standards.

That said, even the most airtight operations can be derailed by reputational issues. In a world where speed of information often supersedes necessity of accuracy, the unfortunate truth with ESG is that perception is reality. Many a company has been unfairly thrust into the crosshairs of media, investors, customers or other stakeholders because they ignored signals that the market perception may not capture the full picture.

Therefore, it’s incumbent upon private equity firms that they spend ample time not only during due diligence but throughout their hold periods conducting perception audits and developing communication action plans to address underlying reputational issues. They’ll find that being proactive around these issues will not only protect the value of their investments, but it’s also likely to enhance it. And that creates a win-win for all parties – limited partners, management teams and
the private equity sponsor themselves.