Comment: Improving fund liquidity through fund finance

The evolution of the fund finance industry has resulted in more banks willing to provide cash to funds, ranging from anywhere between a few million pounds sterling to hundreds of millions of pounds, depending on the size of the fund. A number of institutions are prepared to provide repayment terms of several years, which provides important leverage to the fund and assists the IRR.

These facilities are typically used by private equity to provide liquidity, pending receipt of drawdowns from the fund's investors. However, increasingly they are being used by funds using all-equity to finance deals, with plans to restructure the portfolio company following the transaction as a way to settle management fees and other expenses; and interestingly, to also smooth any foreign exchange issues when a fund needs to invest in a volatile local currency. In addition, there is an increasing appetite from banks to provide liquidity to the GP by providing GP and manager support facilities. These transactions in a number of cases may be unsecured, or only secured against distributions or management fees.

Adept with debt
How this works in practice is the bank will provide a loan upfront to the GP to be used for the GP commitment. The advantage is principals who control the general partner will not be required to finance the full amount of their commitment up front. If the fund performs well, the bank will be repaid its debt out of the relevant distributions that are made to the general partner or other relevant fund entity. The bank may ask for additional credit support in the form of guarantees from the principals or security over the annual management fee from the fund to protect the bank in the event that the fund is not able to make the necessary distributions to repay the debt.

One particular issue that can arise when implementing fund finance facilities is the sensitivity of communicating to investors that the facility is to be put in place and that security will be granted to the bank. On capital call facilities or subscription line facilities that are secured, this is usually required by the bank in order to "perfect" security that has been taken.

Another issue to be aware of with these transactions is whether or not the LPA actually permits the GP to borrow and grant security over the LP commitments. Private equity funds should ensure when drafting the LPA prior to first close that as much flexibility as possible is incorporated into the limited partnership to avoid having to seek investor consent at a later stage.

Fund financing is a rapidly growing and developing area and the current trend is for financial institutions to provide increasingly sophisticated and wide-ranging facilities to funds. A number of banks view this type of lending as quite high-risk for the lender, but others are prepared to take a view on the underlying fund and its future performance, providing such facilities sometimes on an unsecured basis. These same institutions are often also prepared to make loans available directly to the GP with no recourse to the fund. Our prediction is that this trend is likely to continue as more and more funds become aware of the availability of such credit.

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