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Here are my notes from ILPA’s 2020 Members’ Conference workshop on subscription lines. Michael Mascia from Cadwalader, Wickersham, & Taft LLP led the workshop.

The workshop was a thorough review of both common subscription facility terms and more advanced provisions. The workshop was valuable for both investors unfamiliar with subscription facilities as well as experienced investors.

Note: any errors are my own and in no way attributable to Michael Mascia or ILPA

Collateral

• Includes the fund’s right to call capital from LP, capital contributions themselves, and the collateral account

• Includes any enforcement rights

• Does not include any security interest in the fund investments or distributions

Underwriting

• Based almost entirely on LP creditworthiness

o Reputation of sponsor is less important

o Agnostic towards the assets/investments

• There are other facilities that do care about underlying assets – stretch facilities used near the end of the fund’s life; hybrid and NAV facilities (discussed below)

• Full recourse loan to the fund – fund is obligated to repay even if collateral is insufficient

• Almost all subscription facilities are committed facilities – lender is obligated to make the loan

• Always a revolving facility; rarely do you see term sub facilities

• Sub facilities must be explicitly authorized by LPA

• An LP is only obligated to their capital commitment; LP doesn’t have to provide other credit enhancement to the lender

Borrowing Base

• Lender will make an advance up to the borrowing base – percent of the fund’s uncalled capital commitments; max size of the loan is always less than available capital call amount

• As capital is called, uncalled capital commitments decrease and therefore lower the borrowing base

• Doesn’t expand purchasing power like traditional leverage

Sub Facility Repayment

• Subscription lines are typically repaid by capital contributions

• One exception, for example: a real estate fund buys a property with sub line, then takes out permanent financing and repays sub line with the loan

Sub Facility Tenor

• Majority 1-3 years

• Any individual loan may have earlier clean down provision

• Extensions are typically 1 year

Sub Facility Interest Cost

• Average 165 bps over LIBOR

• 150 bps over LIBOR very common

• Lowest source of financing for a fund

o Less expensive than all other asset or investment-level debt

o Smaller deals have higher margins

• Pristine credit performance of sub lines

• Pricing is tiered based on quality of L.P. investors

o Very little information is needed from LPs

o Lenders rely on public information

Borrowing Base Determination

• Borrowing base – 90% for rated institutions (public pension); 65% for unrated institutions – Family Office, HNW investors

• There are concentration limits limiting the borrowing base attributable to a single LP

o Can be 15% for highly-rated institutions; 1% for non-rated institutions or HNW investors

• Will exclude certain investors from borrowing base; but ALL investors are in the collateral base

• Lenders will use shadow ratings – for example, will use corporate parent credit ratings as a proxy for creditworthiness of pension plan

• LPs that use an SPV provide very little information, lender will try to identify credit linkage to the parent company; but obviously there’s a reason the LP formed an SPV

• There is flexibly to increase borrowing size as additional closings occur

Other Borrowing Base Alternatives

• VC lenders use a flat rate: 50% of all unfunded capital commitments

• Coverage ratios: maintain uncalled capital to debt of 2:1

• Less sensitivity to underlying LP classification

Investor Letters

• If LPA provisions are not adequate, lenders may request investor letters

• Investor letters: LPs give various acknowledgments, representations, and covenants to give lenders comfort of LP’s ability to make good on facility

• 25 years ago, sub lines required investor letters from every LP

• Now getting investor letters is a nuisance; large movement away if investors give appropriate acknowledgments in the agreements

• Exceptions where investor letters are used

o If the LPA didn’t adequately address sub line in a way that the lender can get comfort

o An SMA or transactions where 1 or 2 investors have high concentration risk and lender has high exposure – lender wants additional comfort

o Use of investor letters in prior funds

• Typical letter is structured between investor and lender so lender can issue capital call

Exclusion Events

• LP’s will drop out of borrowing base if they file bankruptcy

• Rare to see this happen in practice given the reliability of LPs

Mandatory Prepayment

• If loans exceed borrowing base

• Haven’t really seen this in practice because LPs haven’t defaulted

• Will see this if capital call goes out that reduces uncalled capital base; loan may then be over maximum and will have to be prepaid until under maximum limit

Information Exchange

• Banks wants fund financials as well as any material notice LPs give fund

o For example: to end investment period early

Lesser-Known Benefits

• Avoid the need for true-ups among different close investors:

o Will hold investments on sub line until all closings are complete; then can issue one capital call

• Guaranteeing debt of portfolio company

o Instead of portfolio company paying 10%+, the fund has portfolio company join the sub facility as an additional borrower

o Fund will guarantee borrowing and get the debt at the fund rate - massively reduces interest cost

• Use lender for currency exchange so fund doesn’t have to swap currencies

• Sub line is the working capital line – pay accounting, etc via sub line and then clear out with capital call

• For levered funds - can use sub line to create leverage until fund has built up enough assets to get asset level leverage

• Avoid financing condition in purchase document (for example, real estate – don’t need to have permanent financing committed at purchase)

• Fund can use sub line to assist with hedging activity; can use capital calls and hedging program as security interest

Using Subscription Lines to Fund Distributions

• Lenders don’t like this and will prohibit because they want borrowed fund to go into the asset base that would be part of bankruptcy case in worst case scenario

o Rarely happens in practice

• Can be an option if LPs want a dividend recap

Remedies in Default

• GP will issue cap call if still involved; if GP is removed, lender will issue capital call

• Lenders can prohibit distributions to LPs until loans repaid

• Lenders have the ability to step into GP role and pursue an LP that defaulted; almost never happens given LPs rarely default

Topics Exaggerated in the Press

• Concern regarding uncommitted facilities - gives lender discretion to fund or not

o Tiny portion of market

o GP’s like it because it’s a little cheaper and they can always call capital if needed

• Demand feature on sub lines – lender can terminate facility with short notice (i.e. 12 days)

o GPs stay away because they want certainty of facility

• Concern regarding umbrella facilities – collection of separate sub lines that are documented under one credit

o Agreement with separate schedules for each fund

o No cross-collateralization or cross defaults

o Avoid the need for large GPs to have numerous different facilities

o Any special terms are part of the specific fund schedule

Other Terms

• Capital Call Lines of Credit – same as a traditional sub line but with different terminology; sub lines with flat advance rates are called capital call lines of credit

• Qualified borrowers – portfolio company joins sub facility; portfolio company only has to repay its own loan, not any other loans of the fund

Other Lending Structures – NAV and Hybrid Facilities

NAV Facilities

• Can be a term or revolving facility

• Collateral based on investments, equity of holding companies, and distribution proceed

• Borrowing base reflects eligible investments and applicable concentration limits

• Investment valuations are critical; focus on LTV

• Represents actual leverage compared to a traditional sub line that does not

• NAV facilities are a much smaller market than a typical sub line

• More expensive with more risk for the lender

• Lenders need to understand fund risks and investments

• Typically used for debt funds and Fund of Funds

o Can’t get leverage at the investment level in these funds

o Implemented during or after investment period

Benefits

• Liquidity to support portfolio companies when all capital commitments have been called

• Availability to do follow on investments

• Cheaper than investment-level debt

Hybrid Facilities

• Both collateral and borrowing base incorporate uncalled capital commitments and investment value

Market Update

• Haven’t seen any decline in deal volume through COVID-19

• Credit performance was perfect in GFC and has been through COVID-19

• Had expected NAV facilities to cash sweep (if LTV of loan gets to high – cash flows need to pay down the loan)

o Haven’t seen this because prices have rebounded so quickly;

• Haven’t seen as many underlying companies become qualified borrowers

• Virtually zero LP transfers

• Increased interest in NAV facilities to defend portfolios

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