Developments in Capital Call Lines, NAV Facilities and Other Unique Funding Facilities

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1 Developments in Capital Call Lines, NAV Facilities and Other Unique Funding Facilities Presented by Meyer Dworkin, Davis Polk Yukako Kawata, Davis Polk October 25, 2017 Davis Polk & Wardwell LLP

2 Index Background: Subscription Facilities and NAV Facilities Features of Subscription Facilities Features of NAV Facilities Hybrid Facilities Recent Developments in Subscription Facilities 1

3 Background: Subscription Facilities and NAV Facilities Credit facilities provided to private equity funds dominated by two forms: Subscription Facilities Used for newer funds with significant unfunded capital commitments Loans secured by fund s right to call capital from limited partners and proceeds of such calls Address fund s short term capital needs by bridging time between issuance of call and actual contribution NAV Facilities Used by mature, fully invested funds with significant underlying assets Loans secured by broad base of assets, including portfolio investments Availability subject to borrowing base determined by the net asset value ( NAV ) of portfolio investments Mandatory prepayment upon the ratio of loans outstanding under the NAV facility to specified collateral exceeding a specified threshold 2

4 Structure of Subscription Facilities Investors Investors LPs LPs Lender Main Fund Borrower Offshore Fund (Co- Borrower/Guarantor) 3

5 Features of Subscription Facilities Collateral: The fund borrower, co-borrower/guarantor and general partners of the pledging funds pledge (i) the unfunded capital commitments of the investors, (ii) the right to make capital calls on investors and (iii) the deposit accounts into which investors fund capital contributions UCC financing statements are filed against any pledging fund and its general partner Accounts of pledging funds required to be subject to account control agreements in favor of lender, with control typically springing upon an event of default or borrowing base deficiency Guarantee/Joint and Several Liability Capital call facilities often include an offshore co-borrower or guarantor and the ability to add multiple borrowers who are liable on a joint and several basis. This allows the capital commitments of investors to all funds within the structure to be included in the borrowing base (i.e. lenders will only give borrowing base credit for investors where the applicable fund is either a guarantor of the main fund or co-borrower that is jointly and severally liable with the main fund). 4

6 Structure of NAV Facilities Investors Investors LPs LPs GP Master Fund Borrower Lender Holdco SPV Guarantor underlying portfolio investments 5

7 Features of NAV Facilities NAV Facilities for private equity funds Historically, NAV facilities have been used by PE secondary funds, which pledge their underlying portfolio investments in other PE funds Recently, more traditional private equity funds have been using NAV facilities to borrow against the equity value of their underlying portfolio company investments Such facilities typically take the form of hybrid facilities, and are secured by both unfunded capital commitments and interests in underlying portfolio companies features include (i) the posting of cash collateral in the event the LTV Ratio exceeds a certain threshold and (ii) a mandatory prepayment upon the loan amount exceeding a certain percentage of unfunded capital. Main fund/borrower establishes SPV ( Holdco ) Borrower holds 100% of the equity interests in Holdco Holdco directly owns the portfolio investments included in the borrowing base Guarantee/Collateral: Borrower provides an all assets pledge, including 100% of equity interests in Holdco Holdco guarantees Borrower s obligations and secures its guarantee with a pledge of deposit/securities accounts into which distributions on and proceeds of the portfolio investments are paid UCC financing statements are filed against Borrower and Holdco Accounts of Borrower and Holdco required to be subject to account control agreements in favor of lender Structure provides lenders upon a default with the right to foreclose upon the equity interest in Holdco 6

8 Hybrid Facilities Hybrid Facilities These facilities both look to the value of the underlying assets and take a security interest in the investors capital contributions Include covenants to ensure there are sufficient uncalled investor commitments to repay the loan Particularly useful to funds looking for long term financing that is available from the fund s first close until the end of the life of the fund when all of its commitments have been fully drawn and the fund is fully invested Often a challenge for banks to provide because different bank groups specialize in each type of facility 7

9 ILPA Considerations and Recommendations (June 2017) ILPA Considerations for Limited Partners and the Potential Impacts of the Use of Credit Facilities: Higher risk of GP Clawback Expenses, including an upfront fee and interest expense, can nullify any positive leverage impact on the IRR Potential UBTI exposure for tax-exempt investors Legal risks, such as granting a lender excessive discretion over certain fund management decisions or assignments; compelling investors to submit extensive documentation to lenders Exposure in excess of an investor s pro rata share due to a joint and several liability ILPA Recommendations: Preferred return should be calculated based on when the credit facility is drawn, rather than when capital is ultimately called Caps: Facility should be capped based on uncalled capital, e.g., 15-25% and maximum of 180 days outstanding Facilities should be secured only by LP commitments, not by the underlying assets of the fund Cross-collateralization of credit facilities should be avoided Managers are advised against using the credit facilities to make distributions in anticipation of an exit Potential investors should request managers to provide levered and unlevered IRRs, as well as any tax impact of leverage Quarterly reports to investors should include: the total amount of debt used by the fund and the number of days such debt is outstanding use of proceeds from the credit facility terms of the credit facility (upfront fee, drawn and undrawn fees, etc.) and costs to the fund 9

10 Recent Developments/Issues in Subscription Facilities Overcall Limitations Important to review side letters for any cap on an individual investor s percentage of overall/individual capital contributions There is a growing concern among lenders that such provisions may limit the obligations of a capped investor to fund its full amount in the event there are defaulting investors (limiting the lender s ability to receive the expected amount of capital contributions upon foreclosure) E.g., Assume an investor (the Capped Investor ) was capped at 19.99% of funded capital. For a $100M capital call, if the Capped Investor had a 19.4% ownership, they would fund $19.4M. If a single investor or multiple investors constituting 10% of commitments default, $10M would go unfunded and only $90M would be funded. That would mean the Capped Investor has funded $19.4M of $90.0M, or 21.6%, which is over its 19.99% limitation (and the fund may have to return $1.4M). While lenders continue to push this issue, borrowers have countered that high grade investor defaults would usually have to be fairly significant (and therefore unlikely) for an investor to exceed its cap Transfer Restrictions Lenders will want to ensure that the GP has consent rights over LP assignments in order for the GP to have the ability to at least delay a transfer so that a mandatory prepayment can be made in the case of a transfer to an investor that is less creditworthy. Note that lenders may have concerns if transfers by investors to affiliates are not subject to GP consent. 9