Fund finance
Fund finance originally developed as a means of assisting the administration of funds in terms of deployment of their investors’ commitments. Almost every private equity, real estate and infrastructure fund has a subscription-line facility, which allows the fund to invest in opportunities at short notice by bridging the investors’ commitments. Some funds also package up drawdowns from investors by only drawing quarterly, semi-annually or annually and rely on their subscription-line facilities in the intervening periods for all their cash needs. However, the range of funds finance products that is now available is much wider and can effectively be used to solve the liquidity issues that currently face funds across the private equity, real estate, infrastructure and other asset classes.
The solutions
There are three funds finance products in particular that have exploded in popularity very recently and that we predict will continue to be in demand.
‘Qualified Borrowers’ mechanism under subscription-line facilities
Under a traditional subscription-line facility, the fund is usually the borrower. The fund draws down from the lender and then on-lends the cash to the relevant portfolio companies. A number of our lender clients can provide these subscription-line facilities directly to a portfolio company (a so-called ‘qualified borrower’) backed by a guarantee from the fund. The portfolio companies have direct access to additional liquidity, and the provision of a fund guarantee (or sometimes an equity commitment letter from the fund) to the lender to support this borrowing leaves the lender in pretty much the same position as if it had lent directly to the fund. Subscription-line facilities are typically short-term revolving credit facilities and so this short-term liquidity line can supplement portfolio companies’ revolving credit facilities at the asset level. However, a number of our funds finance lender clients can also provide subscription facilities of two or three years’ duration, which makes this type of available liquidity highly attractive to a portfolio company.
Net asset value (NAV) facilities (for mid- to end-of-life funds)
An increasing number of new NAV facilities are hitting the market. These are facilities provided by lenders secured against the cashflow and/or net asset value of a fund’s entire investment portfolio. The facility is typically provided to an intermediate holding vehicle that sits below the fund and owns all or most of the portfolio companies. The facility is secured against the cashflows of the investment portfolio and often also supported by a share pledge over the intermediate holding vehicle and security over its bank accounts. This ‘intermediate’ financing (i.e., at the holdco level) is a flexible means of getting additional liquidity into the structure (within, and perhaps up to, any borrowing limits in the fund’s limited partnership agreement) without conflicting with existing financing arrangements.
Many sophisticated private equity sponsors were exploring these NAV products before the crisis but are only now actively seeking financing proposals. Some sponsors have questions around whether such financings could trigger change of control issues at the asset financing level if a NAV lender requires share security over the intermediate holding vehicles, given the intermediate holding company sits directly between the investments and the fund. However, there are a number of solutions to avoid these issues – for example, setting up a separate finance company subsidiary of the fund that borrows under the NAV facility and then on-lends the proceeds to the individual members of the investment group. The added benefit of this structure is that it allows the fund to cherry pick which investments it can provide topco security over to the NAV lender, avoiding any breaches of co-investment/shareholders agreements and underlying asset level facilities or the need to obtain regulatory consent if the investment is regulated.
Preferred stock facilities
Some lenders, typically non-bank lenders, can provide liquidity by taking preferred stock in the fund structure rather than by way of a loan facility. This can have the benefit of avoiding any fund level borrowing restrictions, lightening or removing the need for financial covenants and providing limited partners with an alternative to selling their limited partnership interest in the secondary market. Although this form of financing is usually more expensive, it can be particularly appealing to a fund that only has a small concentrated pool of investments remaining in its portfolio.
Conclusion
The Qualified Borrower mechanism, NAV facilities and preferred stock facilities are three very useful solutions to the liquidity needs of funds during the current COVID-19 crisis. Funds are already looking to take out these facilities, either to provide an immediate solution to current liquidity issues, or defensively to ensure that they can weather the storm in the months to come.
Client Alert 2020-285
