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Presenting a live 90-minute webinar with interactive Q&A
Structuring Credit Facilities for Private Equity
Funds: Subscription, NAV and Hybrid Loans
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
THURSDAY, DECEMBER 7, 2017
Zachary K. Barnett, Partner, Mayer Brown, Chicago
Todd N. Bundrant, Partner, Mayer Brown, Chicago
Ann Richardson Knox, Partner, Mayer Brown, New York, NY
Leon Stephenson, Partner, European Head of Funds Finance, Reed Smith, London
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Financing Lifecycle of a Private Equity Fund
Financing Lifecycle of Private Equity Funds
• Subscription Credit Facilities are put in place during the subscription and
investment stages of a private equity fund because of the availability of
uncalled capital commitments that can be used to support/repay loans
• NAV facilities and hybrid facilities become more useful for funds in the end of
their investment stages (or after their investment periods) as a result of
diminished borrowing availability under the typical subscription facility
structure
• A common goal is to unlock the value of private equity fund assets
• Tools are available to obtain liquidity early in the lifecycle of a private
investment vehicle in order to optimize asset acquisition and fund
operation
• Tools are also available to maximize private investment vehicle value in
later stages of the lifecycle
6
Financing Available to Various Fund Types
• Subscription facilities, NAV facilities and hybrid facilities have been
established for private equity funds of all types.
• Buyout
• Power
• Energy
• Infrastructure
• Real Estate
• Mezzanine
• Funds of funds – Primary and secondary
• Venture
7
Subscription Credit Facilities
8
Overview of a Subscription Credit Facility
• A typically revolving credit
facility to a closed end
private equity or real
estate fund.
• The defining characteristic
is the Collateral Package:
The Facility is secured not
by the Assets of the Fund,
but by the Capital
Commitments of the
Investors.
Management
General
Partner Investor
s
Private Equity Fund
Lender
Letters
of
Credit
$
$
“Capital
Contributions”
Returns Fees
9
Overview of a Subscription Credit Facility
• Collateral
• The Investors’ Capital Commitments, Capital Contributions
and the General Partner’s right to make Capital Calls on
the Investors and enforce payment thereof
10
Overview of a Subscription Credit Facility
• Key Propositions
• The Investors are aware of the Facility, the pledge of their
Capital Commitments and that the Lender can make Capital Calls
directly
• The Partnership Agreement of the Fund must permit the Facility
and not have provisions that unduly restrict or otherwise interfere
with the Lender’s rights to repayment
• Fundamental Premise: The Investors must fund their Capital
Contributions without set-off, counterclaim or defense
― The Lender is underwriting the credit wherewithal of the
Investors
― A dispute between the Investor and the General Partner is a
risk that should not be allocated to the Lender
11
Typical Fund Investors
• Institutional investor commitments are what subscription lenders typically
lend against.
• State Pension Funds
• University Endowments
• Foundations
• Insurance Companies
• Corporations
• Financial institutions
• Foreign Pension Funds
• Sovereign Wealth Funds
• Funds of Funds and Secondary Funds
• High Net Worth Individuals and Related Entities
12
Purpose of Borrowings
• Subscription facilities can be used for short term bridging of capital
calls or longer term bridging purposes.
• Generally to bridge the time between the Fund making an
investment (using proceeds under the facility towards the
purchase) and the calling of capital at a later date to repay the
borrowing.
13
Purpose of Borrowings
• Bridge to Capital Calls
• To avoid the need to call capital well in advance of closing an
investment;
• To backstop late capital call proceeds from the fund’s limited
partners;
• To batch capital calls for very active funds rather than calling
capital for each investment (especially useful for funds of funds,
who receive periodic capital calls from some 20-30 underlying
funds);
• 30-120 day repayment and/or cleanup requirement is sometimes
required;
• Longer term repayment (up to three years) where the facility
provides or backstops construction debt during the development
phase of a project before capital is typically called.
14
Purpose of Borrowings
• Bridge to Other Sources of Deal Financing
• To bridge other sources of capital that might not be available or
ready at the time of a given investment;
• In lieu of calling capital to provide that other financing;
• Allows the purchase of an asset outright with facility proceeds.
Permanent debt to follow upon repositioning of acquired asset
(common in real estate funds).
15
Typical Financing Structure
• Subscription facilities are generally structured as senior, secured
revolving credit facilities.
• Committed vs. Uncommitted
― Both types are available in the market;
• Facility size
― $US10million to $US1billion;
• Tenor
― 1-3 year revolving facilities (typically extended as needed);
• Availability
― Loans and/or letters of credit, FX, interest rate or commodity
hedging;
16
Typical Financing Structure
• Security
• Pledge of uncalled capital commitments / capital call bank
account;
• Power of attorney to exercise managers rights to call capital,
etc.;
• Investor letters may be required;
• Advances
• 50-100% of unfunded capital commitments (depending on
financial strength of investors).
17
Short Term Bridge Example
• The following example shows a short term bridge of the equity in a
buyout / acquisition.
• $100MM Buyout / Acquisition
• Sources
― $40MM Subscription Debt
― $60MM LevFin/ABL Debt
― $100MM Total
• Uses
• $100MM Purchase Price
• $100MM Total
18
Short Term Bridge Flowchart
ABC Fund, LP
Portfolio Company
A
Limited Partners
General Partner
Management
Company
Portfolio Company
B
($100)
Portfolio Company
C
Subscription
Credit Facility
Deal Entities
Fund Entities
Equity (from Subscription Credit
Facility ($40)
LevFin or ABL
Credit Facility
Debt ($60)
$40
19
Net Asset Value Credit Facilities
20
NAV Facilities: Overview
• NAV Facility Characteristics
• Tend to be term loans but revolvers are possible
• Borrowing Base is based off of the NAV of underlying investments
• Collateral consists of an equity pledge of the Borrower or Holding Vehicles
who own the investments
• Collateral typically also includes the bank account into which distributions
from such investments are held
• Additional contractual rights may be provided to permit Lenders to direct
the Borrower’s disposition of investments after a default
• Can live alongside a traditional subscription facility
21
NAV Facilities: Typical Structure
Fund
Holding
Vehicle
(Borrower)
Lender
PE
Investment
PE
Investment
PE
Investment
Equity Commitment
$ Loans
22
NAV Facilities: Types of Borrowers
• Can either be an acquisition financing or used to lever an existing investment
portfolio
• Typically used by Secondary Funds (fund of funds that acquire PE interests on
the secondary market at a discount)
• Other potential consumers include Insurance Companies (for capital relief),
Family Offices or other Investors with portfolios of private equity investments
seeking levered returns.
23
NAV Facilities: Limitations
• Not all Borrowers or Holding Vehicles are 100% owned
• Underlying investment LPA’s may contain restrictions on
“indirect” transfers or pledges of the LP interests
• Priority risks
• Equity pledge is above the level of the investments, so pledges on
the investments themselves prime you
• Substantive consolidation
• Cumbersome Foreclosure/Liquidation Process
• illiquidity of underlying LP interests (GP consents to sales and
transfers to third parties)
24
NAV Facilities: Credit Features
• Fund Level Capital Commitments and Fund NAV Requirements
• Typically have Guarantees from Fund if Borrower is a shell (to bridge uncalled
capital and/or for full facility amount)
• No other debt at level of Borrower/Holding Vehicle and sometimes also places
limits on debt at Fund level outside of Subscription Facility
• Amortization and Cash Sweep/LTV Covenants
• Agreements to cooperate in Liquidation
25
NAV Calculation
• Example Eligible NAV Calculation:
• Lowest of (a) aggregate “net asset value” of Eligible
Investments as calculated by underlying Fund Sponsor in most
recently provided valuation; (b) Borrower/Fund’s valuation in
good faith and in accordance with its investment policy; and
(c) sometimes, acquisition cost
• minus
― NAV attributable to investments subject to exclusion events or write-downs will
be excluded
― Portion of NAV of eligible investments in excess of concentration limit excluded
― Typically the valuation is quarterly given sponsor reporting, however if NAV is
adjusted downward if Fund/Borrower recalculates value of the investment
intraquarter downwards adjustments are permitted
― Typically there is not a dispute resolution mechanism, but some lenders may
require in limited circumstances
26
NAV Calculation
• Eligible Investments:
― Evidence of ownership
― Ongoing ownership may be difficult to establish (typically rely upon transfer
agreements, evidence of capital account statements or Fund financial
statements/auditor letter which are not contemporaneous with the
financing)
― Due diligence on assets may be restricted by confidentiality provisions in
underlying Investment agreements
― Negative pledge on investments and Borrower/Holding Vehicle Equity
― Carve-outs for liens provided by investment documents as most fund sponsors
retain a lien in order to secure obligation to contribute capital
• Static pool of Eligible Investments at closing
― Often anticipates a mechanic to add new investments to pool with consent of
Lender
― Sometimes an additional basket for related primary investments to existing Eligible
Investments is provided in advance
― Borrower often may add new investments that are not eligible and the capital
contribution obligations are covered off.
27
• Eligible Investments - Concentration limits
― Based on NAV of largest investments
― Sponsor diversification
― Investment type (infrastructure/buyout, etc.)
― Geographical limitations
― Concentration limits are more stringent where borrower has ability to add Eligible
Investments with no or limited Lender/Agent consent
• Eligible Investments – Exclusion Events:
― Bankruptcy or insolvency events of Investment Sponsors and Borrower/Holding Vehicles
― Failure by Fund or portfolio company to pay capital contribution obligations as they
become due or “defaulting investor” status
― Write-off or material write-own by Fund of the investment (many Lenders simply permit
the material write down to adjust the borrowing base rather than exclude entirely)
― Some Lenders require additional items including no going concern statement by
auditors/change of GP of underlying fund, etc.
NAV Calculation
28
NAV Facilities: Fund Level Covenants
• Minimum Fund Level NAV
• Fund’s capital commitments from its investors must be sufficient
to support the Guaranty obligations/obligations and
Commitments to underlying Investments (not always expressed
as a covenant)
• No change of control of Fund/Borrower/GP/Manager
• Co-Invest entities may be permitted, subject to approval by
Agent/Lenders, equity pledge of Borrower and
guarantees/equity contribution obligations from Co-Investors
• If Holding Vehicles are not wholly-owned additional issues may
result
29
Hybrid Credit Facilities
30
Hybrid Credit Facilities
• Facility that look down to the underlying assets but also have recourse
to the undrawn investor commitments
• Useful for:
• funds looking for long-term financing available from fund close to end of life
• funds mid-life when fewer undrawn commitments available
• allows lender to “structure around” any particular inadequacies in the financing
structure
• may help pricing and financing terms that are available for a simple NAV facility
• Real Hybrid or Subscription line facility with NAV covenant?
• Challenges to lenders
• Challenges to funds
• Financing Structure and guarantee structure
• Fund Structure to remain the same and for lender to have control of
cash flowing up and down the structure
31
Hybrid Credit Facilities
• Finance documentations needs to be structured to take account of
recourse looking up and looking down
• NAV covenants
• Loan to Value covenants
• Undrawn capital commitments to financial indebtedness covenants
• Consolidated LTV/Undrawn capital covenants
• Representations and undertakings on underlying assets and on investor commitments
and partnership documents
• Events of Default
• Borrowing Base and Portfolio Value affected by defaults of investors and underlying
asset default
• Security over SPV and investors commitments, and possibly underlying assets directly
• No limited recourse language
• Multiple bank accounts – receiving investor commitments and distributions
32
Collateral and UCC Issues
33
Types of Collateral
• Subscription Facilities:
• Uncalled capital commitments
• Rights to call capital and enforce capital calls
• Deposit accounts into which investors contribute their capital
• NAV Facilities:
• Equity interests in the borrower and/or portfolio investments
• Deposit accounts into which distributions/proceeds in respect of the
portfolio investments are distributed
• Hybrid Facilities: some combination of the above
34
Collateral Structure
• Security over SPV entity holding the loan or equity interests
• Direct security over the loans or equity interests difficult but in some
circumstances may be advisable
• Consents from underlying borrowers and GPs
• Transfer agreements for transferring assets into the SPV
• Need for more than one SPV holding the underlying assets?
• Jurisdictional issues in relation to security and cost/benefit analysis
• NAV facilities to PE funds more structuring needed and bespoke collateral
provided
• Perfection in different jurisdiction
35
UCC Perfection Issues – Pledge of Equity Interests
• The manner in which a Lender obtains a valid security interest in equity may
vary depending on how the equity interests are categorized for perfection
purposes.
• Equity interests in corporations are “securities” under Article 9 of the UCC. If
the equity is represented by a certificate, the Lender will ordinarily perfect
its security interest by taking possession of the certificate.
• Portfolio Companies formed as LLCs or partnerships may not have equity
interests represented by certificates, and such equity interests are generally
characterized as “general intangibles” for UCC purposes. Lenders perfect their
security interest by filing a UCC financing statement.
• The UCC also permits entities to “opt into” Article 8 of the UCC, in which the
equity of such entities would be considered securities for UCC purposes
instead of general intangibles.
36
UCC Perfection Issues Continued…
• If the investments of a portfolio company are held in street name in a
securities account, a Lender may seek to obtain a SACA (securities account
control agreement) over the account or a lien over the securities entitlement
in order to have the best means of perfection.
• Perfection issues will arise if the equity being pledged is not a US entity, or if
the equity is held in a securities account outside of the US. In these cases, the
laws of non-US jurisdictions may apply for perfection purposes.
37
Thank You
Zachary K. Barnett
Mayer Brown
Todd N. Bundrant
Mayer Brown
Ann Richardson Knox
Mayer Brown
Leon Stephenson
Reed Smith
