When fund managers and service providers gathered at Private Equity International’s CFOs & COOs Forum New York in late January, one of the hot topics of discussion was the use of fund finance.
Delegates’ questions centered on the practical aspect of using lines of credit at the fund level.
Here are a few takeaways:
How big is the fund finance market?
One lender estimated that there’s about $400 billion in outstanding subscription lines of credit, with the bulk, or 60 percent, in the US. About 60 percent of the limited partner base backing these lines is US-based, he said.
Hamilton Lane also recently disclosed that about 90 percent of the private equity market uses lines of credit, compared with 60 percent in 2009-10.
How should fund sponsors pick lenders?
Panellists said the economics – how much lenders charge – should be the biggest criteria to take into consideration, but not the only one.
Existing relationships, particularly with banks that may already be lending to portfolio companies, are also important. “We went with what we perceived was the leader in that space,” said one GP.
Does a fund’s strategy matter to lenders?
While lenders don’t underwrite a fund’s strategy per se, it’s certainly a consideration. If it’s a first-time fund, a greater share of money may come from friends and family, which usually have lower ratings than institutional investors, making the fund more difficult to underwrite.
Should funds choose committed or uncommitted lines?
With uncommitted facilities, banks don’t allocate capital to the line but rather simply agree to lend. A committed facility gives greater certainty of funds to the borrower.
A couple of delegates and panellists said they had shifted in recent years from committed lines of credit to uncommitted ones. Although they charge more in interest – but lower fees – uncommitted facilities offer managers greater flexibility.
Are lines of credit available for all fund structures?
While the commingled fund lends itself better to a subscription line of credit due to the diversification and sheer number of limited partners backing it, credit facilities are available for other structures as well, including separately managed accounts and co-investments.
“The real difference is that with a mega-fund, you have 40 or 50 limited partners, and you’re focused on LPs individually but only to a limited extent,” another delegate said, adding that not every LP has to be rated AAA in a commingled fund while the creditworthiness of investors in a separately managed account will be scrutinised more and will have to be more robust.
What are LPs’ views on the use of credit facilities?
One GP said its investor feedback has been generally positive. “Investors today are sophisticated,” he said. “But you have to be prepared to answer questions and address concerns that they may have.”
Some of these questions may centre around the amount of leverage at the portfolio company level or the use of the credit line. “You have to map it out and help them understand the true mechanism of the facility in place,” he said, adding that a very sensitive topic with LPs is whether a credit facility is going to impact when a manager enters the carry in a fund.