Presenting a live 90-minute webinar with interactive Q&A Structuring Credit Facilities for Private Equity Funds: Subscription, NAV and Hybrid Loans THURSDAY, DECEMBER 7, 2017 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: 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 The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
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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 Management General Partner Fees Private Equity Fund $ $ Capital Contributions Investor s Letters of Credit Returns 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. Lender 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 Tenor $US10million to $US1billion; 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. Uses $100MM Buyout / Acquisition Sources $40MM Subscription Debt $60MM LevFin/ABL Debt $100MM Total $100MM Purchase Price $100MM Total 18
Short Term Bridge Flowchart Fund Entities Limited Partners General Partner Management Company ABC Fund, LP $40 Subscription Credit Facility Deal Entities Equity (from Subscription Credit Facility ($40) Portfolio Company A Portfolio Company B ($100) LevFin or ABL Credit Facility Debt ($60) Portfolio Company C 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 Equity Commitment Holding Vehicle (Borrower) $ Loans Lender PE Investment PE Investment PE Investment 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
NAV Calculation 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. 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 zkbarnett@mayerbrown.com Todd N. Bundrant Mayer Brown tbundrant@mayerbrown.com Ann Richardson Knox Mayer Brown aknox@mayerbrown.com Leon Stephenson Reed Smith lstephenson@reedsmith.com