Funds: Subscription, NAV and Hybrid Loans THURSDAY, DECEMBER 7, 2017 - - PowerPoint PPT Presentation

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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

• peration
• 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

• f

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 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