The following risk disclosure is a summary of material risks that could adversely affect the value of an investment in our strategies. Any discussion of risks herein is superseded by and subject to any risk discussion in the offering documents of any strategy and Providence’s Form ADV Part 2A.
Risks Related to the Nature of a strategy’s Investments
Many of a strategy’s investments will be highly illiquid and there can be no assurance that a strategy will be able to realize a return on such investments in a timely manner. Consequently, dispositions of such investments may require a lengthy time period or may result in distributions of securities in kind to investors that may or may not be marketable. Certain securities in which a strategy will invest will be the most junior in what typically will be a complex capital structure, and thus subject to the greatest risk of loss. Certain of a strategy’s investments are in businesses with little or no operating history. Certain of a strategy’s investments may be in portfolio companies with high levels of debt or may be in leveraged buyouts. Leveraged buyouts by their nature require companies to undertake a high ratio of fixed charges to available income. Such investments are inherently more sensitive to declines in revenues and increases in expenses. To the extent a strategy makes debt investments, a strategy will be subject to additional risks, including those related to credit and market risks and special risks associated with investing in bank loans and participations, unsecured loans, second-lien loans, non-investment grade debt and other loans and debt instruments. Since a strategy will only make a limited number of investments, and because a strategy’s investments generally will involve a high degree of risk, poor performance by a small number of investments could severely affect total returns to a strategy and its investors.
Inflation Risk
Inflation risk is the risk that the value of assets or income from investments will be less in the future as inflation decreases the value of money (i.e., as inflation increases, the values of a strategy’s assets can decline). At times, governments may attempt to manage inflation through fiscal policy, such as by raising taxes or reducing spending, thereby reducing economic activity; conversely, governments can attempt to combat deflation with tax cuts and increased spending designed to stimulate economic activity. Inflation rates may change frequently and significantly as a result of various factors, including unexpected shifts in the domestic or global economy and changes in economic policies, and a strategy’s investments may not keep pace with inflation, which may result in losses to limited partners. In addition, if a portfolio company is unable to increase its revenue in times of higher inflation, its profitability might be adversely affected. A rise in real interest rates may also result in higher financing costs for portfolio companies and for a strategy and could therefore result in a reduction in the amount of cash available for distribution to a strategy’s limited partners.
Highly Competitive Market for Investment Opportunities
The business of Providence is highly competitive and the success of a strategy as a whole depends upon the identification and availability of suitable investment opportunities. The activity of identifying, completing and realizing attractive investment opportunities is highly competitive and involves a high degree of uncertainty, especially with respect to timing. The availability of investment opportunities will be subject to market conditions, the prevailing regulatory conditions and the political climate in industries and regions in which a strategy may invest and other factors outside the control of a strategy. There can be no assurance that a strategy will be able to identify and complete investments that satisfy its investment objectives, or realize the value of such investments, or that it will be able to invest fully all of its capital commitments.
Valuation of Assets
There is no actively traded market for most of the securities owned by a strategy. The process of valuing securities for which reliable market quotations are not available is based on inherent uncertainties; as a result, the fair values may differ from (i) values that would have been determined had an active market existed for such securities and (ii) the prices at which such securities may ultimately be sold. Additionally, a strategy follows ASC 820 which may prohibit Providence from considering facts and circumstances it may deem relevant such as blockage factors and buyer-specific synergies. The assets of a strategy are valued based, to the extent possible, on prices obtained from independent third-party sources including exchanges. However, third-party pricing information may, at times, not be available regarding certain of a strategy’s assets. The valuation of those assets for which a third-party price is not obtained will be based on other sources deemed reliable. Providence has broad discretion in determining the value of a strategy’s investments, and there are circumstances where Providence is incentivized to determine valuations that are higher or lower than the actual fair value of investments. For example, under certain circumstances, the valuations of investments will affect the amount and timing of any carried interest payable by investors and management fees. Because of Providence’s broad discretion in determining investment valuations, including broad discretion to determine whether or not to write down an investment, it faces an inherent conflict of interest between determining fair valuations and increasing its own revenues, and there is no guarantee that such conflict will be resolved in the favor of a strategy. Providence is not under any liability (including any obligation to remit excess management fees or performance allocations to a strategy or any of its limited partners) if a price reasonably believed to be an accurate valuation of a particular asset of a strategy is found not to be such.
Lack of Diversification Risk
A strategy may not be highly diversified. Lack of diversification would expose a strategy to losses disproportionate to market declines in general if there were disproportionately greater adverse price movements in the particular investments held by a strategy. To the extent a strategy invests a relatively high percentage of its assets in a limited number of portfolio companies, countries, regions, markets, industries or sectors or invests during a single economic cycle or shorter timeframe than initially intended, a strategy will be more susceptible than a more widely diversified investment partnership to the negative consequences of a single corporate, economic, political or regulatory event.
Investing in Growth Businesses
Certain strategies may make investments in growth companies. These companies may be characterized by short operating histories, evolving markets, intense competition and management teams that have limited experience working together. A portfolio company may need to implement appropriate sales and marketing, inventory, finance, personnel and other operational strategies in order to become and remain successful. A strategy’s returns will depend upon Providence’s ability to find and invest in companies that can successfully combine these strategies where products and markets are constantly evolving. There can be no assurance that Providence will be able to find and invest in a sufficient number of these companies to meet investor return expectations.
Investments in Smaller Capitalization and Less Established Companies
A strategy may invest a portion of its assets in companies with small, mid and “small” large capitalizations and/or less established companies. While Providence believes these assets often provide significant potential for appreciation, such investments involve higher risks in some respects than do investments in stocks of larger and/or more established companies. For example, such companies tend to have fewer resources and, therefore, are often more vulnerable to financial failure. Such companies also may have shorter operating histories on which to judge future performance and in many cases, if operating, will have negative cash flow. In addition, the management teams of smaller and/or less established companies may be less experienced and less capable in some cases than is typical of larger companies. As such, these investments should be considered highly speculative and may result in the loss of a strategy’s entire investment.
Control Positions
As part of its strategy, a strategy may seek certain portfolio investment opportunities that allow a strategy to either acquire control or exercise significant influence over the management, operation and strategic direction of certain portfolio companies in which it invests. The exercise of control and/or significant influence over a company imposes additional risks of liability for regulatory non-compliance, environmental damage, product defects, failure to supervise management and other types of liability in which the limited liability of business operations may be ignored. The exercise of control and/or significant influence over a portfolio company could expose a strategy to claims by such portfolio company, its security holders, its creditors and its regulators. While Providence intends to manage a strategy in a way that it believes will minimize exposure to these risks, the possibility of successful claims cannot be precluded.
Risks Related to Reliance on Management of Portfolio Companies.
While it is generally Providence’s intent to invest in companies with established operating management in place, there can be no assurance that such management will continue to operate the companies successfully. Although Providence will monitor the performance of each investment, Providence will rely upon management to operate the portfolio companies on a day-to-day basis.
General Market and Economic Conditions
Investments made by a strategy may be materially affected by market, economic and political conditions in the U.S. and in certain cases in non-U.S. jurisdictions, including factors affecting interest rates, the availability of credit, currency exchange and trade issues. These factors could adversely affect liquidity and the value of a strategy’s investments and/or reduce the ability of a strategy to make new investments. In addition, certain recent bank failures could be a sign of systemic economic weakness that could be revealed over time, and the effect on inflation of the related remedies by the U.S. federal government could cause further adverse economic implications. Such failures have also caused volatility in markets generally.
Non-US Investments
Certain strategies are exposed to risks of investments outside of the United States, including currency exchange risk, inflation risk, tax risk and geopolitical risk among others.
Minority Investments
A strategy may also make minority equity investments in portfolio companies or roll over a portion of its holdings in connection with a portfolio company sale where it may have more limited influence. There can be no assurance that a strategy will be able to negotiate control provisions or otherwise exercise control in such situations which may limit a strategy’s ability to bring about operating, strategic or other changes at such companies and may limit exit opportunities. Certain of the portfolio investments may be made through jointly owned partnerships, joint ventures or other structures alongside one or more funds sponsored by other private equity firms as well as Providence. Such portfolio companies may have economic or business interests or goals that are inconsistent with those of a strategy, and a strategy may not be in a position to protect the value of its investment in such portfolio companies. In addition, if a strategy takes a minority position in publicly-traded securities as a “toehold” investment, such publicly-traded securities may fluctuate in value over the limited duration of a strategy’s investment in such securities, which could potentially reduce returns to investors.
Operational Risk
Each strategy depends on Providence to develop the appropriate systems and procedures to control operational risk. Operational risks arising from mistakes made in the confirmation or settlement of transactions, from transactions not being properly booked, evaluated or accounted for or from other similar disruptions in Providence’s operations may cause a strategy to suffer (a) financial losses, (b) the disruption of its business, (c) liability to clients or third parties, (d) regulatory intervention or (e) damage to its reputation. Human error (including, without limitation, trading errors), system failure or other problems with any of the operational processes could result in material losses or costs, which will generally be borne by a strategy.
Systemic Risk
Credit risk may arise through a default by one of several large institutions that are dependent on one another to meet their liquidity or operational needs, so that a default by one institution may cause a series of defaults by the other institutions. This is sometimes referred to as a “systemic risk” and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which a strategy interacts on a daily basis.
Risks Related to Pandemics and Other Diseases
The global outbreak of the novel coronavirus (“COVID-19”) has resulted in, and will continue to result in, for the foreseeable future, restrictions on travel, limitations on transportation, production and sale of goods and services, prohibitions on large events, efforts to engage in “social distancing,” and shelter in place practices that have continued to meaningfully disrupt the global economy and certain of Providence’s portfolio companies and, given the unprecedented nature of COVID-19, has introduced greater uncertainty regarding future market conditions and portfolio company results. New variants and low rates of vaccination in certain parts of the world have hampered recovery efforts and continue to create further uncertainty. Even as restrictions have been lifted in certain jurisdictions, they have been reimposed in others, and this pattern could continue as certain jurisdictions experience resurgences of COVID-19. Although the long-term economic fallout of COVID-19 is difficult to predict, it has contributed to, and is likely to continue to contribute to, market volatility, inflation and systemic economic weakness. As the world adapts to a new outlook on how to balance the risk of illness against the desire for in person human connection, the COVID-19 pandemic and its effects are expected to continue, and, therefore, the economic outlook, particularly for certain industries and businesses, remains inherently uncertain.
Risks of Artificial Intelligence (“AI”)
Providence’s ability to use, manage and aggregate data may be limited by the effectiveness of its policies, systems and practices that govern how data is acquired, validated, used, stored, protected, processed and shared. Failure to manage data effectively and to aggregate data in an accurate and timely manner may limit Providence’s ability to manage current and emerging risks, as well as to manage changing business needs and adapt to the use of new tools, including AI. While Providence may restrict certain uses of third-party and open source AI tools, such as ChatGPT, Providence’s employees and consultants and a strategy’s portfolio companies may use these tools, which poses additional risks relating to the protection of Providence’s and portfolio companies’ proprietary data, including the potential exposure of Providence’s or portfolio companies’ confidential information to unauthorized recipients and the misuse of Providence’s or third-party intellectual property, which could adversely affect Providence, a strategy or portfolio companies. Use of AI tools may result in allegations or claims against Providence, a strategy or portfolio companies related to violation of third-party intellectual property rights, unauthorized access to or use of proprietary information and failure to comply with open source software requirements. Additionally, AI tools may produce inaccurate, misleading or incomplete responses that could lead to errors in Providence’s and its employees’ and consultants’ decision-making, portfolio management or other business activities, which could have a negative impact on Providence or on the performance of a strategy and portfolio companies. Such AI tools could also be used against Providence, a strategy or portfolio companies in criminal or negligent ways.
Regulatory Proposals with Respect to Private Funds and Investment Advisers
Providence is subject to regulation by the U.S. Securities and Exchange Commission (“SEC”). In recent years, the SEC has proposed and adopted several new rules and amendments to existing rules under the Advisers Act related to registered advisers and their activities with respect to private funds that fundamentally increase compliance costs and burdens on Providence and a strategy. In particular, on August 23, 2023, the SEC adopted rules and amendments (collectively, the “Private Funds Rules”) specifically related to private funds. The SEC has also recently proposed other new rules and rule amendments under the Advisers Act in respect of: ESG disclosures, the safeguarding of client assets, additional Form PF reporting obligations (in addition to those recently adopted), cybersecurity risk governance, the outsourcing of certain functions to service providers, changes to Regulation S-P and the use of predictive data and associated conflicts of interest.
The Private Funds Rules, and the other proposed rules, to the extent adopted, are expected to significantly increase compliance burdens and associated costs (which, to the extent permitted under the governing documents, and consistent with the law and the Private Funds Rules, will be treated as partnership expenses borne by limited partners of a strategy) and complexity and possibly restrict the ability to receive certain expense reimbursements in certain circumstances. This, in turn, also would be expected to increase the need for broader insurance coverage by Providence and increase such costs and expenses charged to a strategy and its investors. In addition, these amendments could increase the risk of exposure of Providence to additional regulatory scrutiny, litigation, censure and penalties for noncompliance or perceived noncompliance, which in turn would be expected to adversely (potentially materially) affect Providence and a strategy’s reputation, and to negatively impact a strategy in conducting its business (thereby materially reducing returns to investors). There can be no assurance that the Private Fund Rules and any other new SEC rules and amendments will not have a material adverse effect on Providence, a strategy, its investments and/or limited partners.