There has been a marked increase in demand from funds for umbrella fund finance facilities.
Typically, capital call and subscription line facilities have been provided on a separate fund-by-fund basis so that an asset manager that has various funds with different investment strategies would be required to seek separate financing for each fund.
An umbrella facility is a facility which an asset manager and its lenders negotiate and document on day one, and then as additional fund vehicles are established such fund vehicles accede to the umbrella facility as borrowers (and guarantors) and benefit from the financing provided under the existing umbrella facility terms.
Setting up an umbrella facility can significantly assist the fund in terms of minimising both cost and execution time dealing with separate facilities. This type of umbrella financing structure will become more and more important as the size and range of assets under management by asset managers grow. There is a definite trend in the market for traditional private equity funds of a certain critical size to diversify into other strategies such as direct lending, special opportunities, real estate and infrastructure investment.
In parallel with this there has been a significant increase in funds focused specifically on one of these areas (with direct lending being the most high profile since the financial crisis) which are looking to bring their funds under umbrella facilities. The expansion by funds into a range of investment strategies is usually achieved by asset managers setting up separate and distinct funds each focusing on these different strategies, each of which will very often require a subscription line or other fund finance facility.
An umbrella facility agreement will be structured in a way to allow multiple funds to be a party to it on signing of the facility agreement but also at a later date. Typically there is an accession or joinder mechanism. A fund which wishes to accede to an umbrella facility at a later date will deliver a facility request to the agent together with certain agreed conditions precedent, but always subject to the lenders needing to be satisfied as to the credit worthiness of the acceding fund’s investors for the purpose of inclusion in the financial covenants/borrowing base provisions.
The facility request is likely to set out certain commercial terms that will apply to this new facility to be created, including the pricing, the covenant ratios of undrawn investor commitments in this fund to its financial indebtedness and the term of this facility. In addition to having to allow for additional funds to accede, the umbrella facility will also typically have to provide broader operational flexibility given the potential diversity of funds operating under it.
One example would be available currencies. In an umbrella facility for a group of large cap funds operating across a range of jurisdictions and investment strategies, it would not be uncommon for the funds to need the ability to drawdown in give or six pre-agreed currencies, so lenders will need to ensure they are able to meet these funding needs.
The umbrella facility may also provide for certain amendments to or deviations from some of the existing general provisions of the umbrella facility as it relates to this particular facility. The agent or lenders will generally have sole discretion whether to allow the new fund to accede to the umbrella facility and usually there will be an increase in the facility amount at the time the new fund accedes. This should happen through an accordion mechanism to avoid having to make more general amendments to the terms of the existing facility.
In terms of conditions precedent, the new fund joining the facility will need to provide the usual documentary conditions precedent such as board resolutions, officers certificates and up to date fund documents. Due diligence will need to conducted in respect of the limited partnership Alex Griffiths agreement and other fund documents by the lenders’ lawyers to ensure there are no issues with the fund entering into the financing.
Furthermore, the terms of any side letters and subscription agreements will also be delivered to the lenders’ lawyers. This diligence workstream is not to be under estimated by lenders. Where a number of funds are signing on day one or subsequently acceding to an umbrella facility, the fund documents for each will likely have been in operation for different periods of time. As such, more mature funds in particular may encounter issues around the ability to enter into fund finance transactions in their constitutional documents.
That will mean that the lenders will need to be comfortable that each fund can, among other things, borrow, guarantee and grant security in respect of such facilities. If any amendments or other options need to be looked into in order to get this comfort then it is important that this is done early in the transaction.
New security documents will be entered into to secure the investor commitments of any acceding fund. However, assuming the fund is established in the same jurisdiction as one of the existing fund borrowers, this should be broadly based on the form of the security documents already executed on the original closing and funds may often request that the original form of security documentation for each relevant jurisdiction is used to ensure speed of execution by any new fund.
Although the conditions precedent will be largely similar to those delivered on original close of the umbrella facility, there will not be any need to negotiate the terms of a new facility agreement nor to deal with execution of a full closing.
Drafting of umbrella facilities
The umbrella facility will need to be drafted very carefully to ensure that the definitions used in the facility agreement can apply to all new funds that accede to the facility agreement. For example, you would typically have a number of definitions such as “Partnership Agreement”, “Capital Commitments”, “Investment Period” and “Defaulting Partner” that may just cross-refer to the definitions set out in the relevant limited partnership agreement of the fund borrower.
If different funds have different limited partnership agreements with different definitions, then the definitions in the umbrella facility need to be drafted sufficiently broadly to pick up each definition across different limited partnership agreements and it is important that the fund’s counsel accounts for this when negotiating the LPA(s) for incoming funds with investors.
Furthermore, if a fund entity happens to be a corporate entity (rather than a limited partnership entity) this will also need to be catered for. For example, the representation on due establishment will also need to capture due incorporation (if the fund is a corporate entity).
We have designed umbrella facility precedents with our lender clients which allow this flexibility and which greatly minimise the risk of needing to do an amendment each time a new fund accedes to the umbrella facility. Generally speaking, the umbrella facility will have separate sub-facilities with sub-facility groups of entities (often called “fund groups”).
If a particular fund has parallel funds, feeder funds or alternative investment vehicles, the lenders will usually expect them to cross-guarantee the debt of the borrower within their fund group and therefore become obligors under the facility. The fund will not want any cross-collateralisation or cross-guarantees between different fund groups with different strategies, but should usually accept cross-guaranteeing and cross-collateralisation within the same fund group.
When are these facilities particularly useful?
We have seen large cap private equity and direct lending funds put in place umbrella facilities to ensure consistency across different funds and to ensure that the funds are getting market terms on facility agreements. It also allows the fund to establish a clear group of relationship lenders that participate in financing all of the funds of that particular asset manager.
This could be a challenge if a particular lender only wants to provide subscription line financing to a particular fund of the asset manager such as a venture or buyout fund, but nothing prevents the asset manager still entering into standalone bilateral financing for some of its fund vehicles.
With investors now asking a lot more questions around the credit strategy of funds, having an umbrella facility in place on first close of the fund may provide the asset manager and its investors with more certainty around the fund financing strategy of the funds to be managed by such an asset manager.
We believe there will be a substantial increase in the use of these facilities as terms in the fund finance market become more competitive and as more lenders enter the space looking to participate in syndicated or club facilities.
A lot of funds want to put in place their fund finance facility quickly and efficiently so that they can focus on their underlying investments. Umbrella facilities may be a way of short-cutting the amount of time funds need to allocate to negotiating and putting in place their fund finance facilities.
Furthermore, they allow lenders to form a close and ongoing relationship with an asset manager and to participate in the financing of several of its funds under management and, in return, get a valuable flow of information in respect of the range of funds pursuant to the facility agreement’s reporting obligations.
As the competition in this area increases so will come further discussions around the specific terms funds want to achieve in their umbrella facilities. We expect that such discussions will be around the customary economic issues such as pricing, but also more forward-looking issues such as: the availability of accordion facilities and how these are included on day one; bullet repayments; options to capitalise interest payments; and more negotiation around transfer mechanics and amendments.
These issues are important to funds in the more established capital call facility market where only one fund is borrowing. However, given the nature of umbrella facilities in that they bind the fund and potentially many of its other fund groups/investment strategies and lenders to terms for longer periods of time, we anticipate that negotiations on these and similar issues will form a key part of headline discussions from even earlier in future transactions.
We also anticipate that the use of umbrella facilities could become more prevalent among mid/large cap funds, in addition to the large cap funds which have been the most prolific users to date. The rate at which mid/large cap funds across all investment strategies are capitalising on the bumper fundraising year most experienced in 2015 has been impressive to say the least.
Add to that the frequency and levels at which many have been able to raise funds since then, and the expansion of umbrella facilities in this area seems to be a likely next step.
Leon Stephenson is a partner and head of funds finance and Alex Griffiths a senior associate in the funds finance team at law firm Reed Smith in London.