As the fund finance industry has evolved, borrowers are facing more choice than ever when it comes to who to partner with. So how are lenders differentiating themselves and how should CFOs be making their selection?
First and foremost, borrowers need to decide whether they should be working with a bank, fund or institutional investor and it very much depends on the nature of the transaction.
“If you have a large, diversified secondaries fund, invested in well-known managers, that is looking for financing for a couple of years to provide additional acquisition capacity or to accelerate distributions, then you are likely to lean towards the big banks,” Khizer Ahmed, Hedgewood Capital Partners’ founder, explains.
“But if you are looking for a NAV facility, secured by a smaller number of assets, possibly facing some challenges, or a facility being put in place in the early years of a fund when blind-pool risk is high, then you are likely to gravitate toward non-bank lenders. Of course, you will end up paying a bit more, but you stand a better chance of securing more favourable terms than with a traditional lender. Meanwhile, if you are looking to go long on the maturity spectrum, then insurance companies are a good bet because it suits the longer-term nature of their liabilities.”
As the fund finance industry matures, lenders also increasingly specialize. Some are focusing on certain private markets asset classes, for example, displaying a particular appetite for VC. Others are focusing heavily on either subscription lines or NAV financing.
Investec’s head of secondaries, Ian Weise, however, cautions that too much specialization can be detrimental to the borrower. “We see banks doing NAV financing in the north wing and sub lines in the south wing, with very little communication between the two. But we believe having the same team to do both enables you to find a solution that best fits the client,” he says. “We will see more specialization, but if lenders become over-specialized, that may potentially be at the cost of providing holistic solutions for clients.”
This holistic view is enabling some lenders to offer hybrid facilities incorporating elements of both subscription and NAV financing. Investec is one such bank. Yet these kind of facilities are rare. “In theory they make a lot of sense, but they are pretty hard to implement in practice given the different credit underwriting required for a subscription line versus a NAV line and the different credit markets for both products,” says Wes Misson, head of fund finance at Cadwalader.
There are other considerations a CFO will need to take into account. Mid-market firms, in particular, are unlikely to be looking for fund finance facilities in a vacuum. These loans are normally one part of a broader banking relationship. “The really big asset managers may have the resources to work with a non-traditional lender for their subscription line or NAV facilities, and then have a different banking platform for traditional services,” says Blue Wolf Capital CFO Joshua Cherry-Seto. “But at the smaller end, firms tend to look for a full-service offering.”
Misson adds: “Lenders can differentiate themselves based on their ability to offer bolt-on services, such as FX and currency hedging. Other points of differentiation include the ability to give credit to multiple asset classes under the same facility, as well as flexibility on terms, including tenor; execution certainty and relationship-based lending.”
Price is also always a consideration, of course. But Crestline Investors partner Dave Philipp believes many CFOs are focused on flexibility of structure and all-in cost rather than just the coupon. For example, delayed draw down structures and recyclability, which mean they can secure a facility but be flexible on when they draw or deploy the capital. Repayment terms are another key issue. In an uncertain environment, it can be hard for a CFO to predict when exit markets will reopen, and optionality is extremely valuable.
“Flexibility around repayment terms has been one of the more prevalent negotiation points,” says Hark Capital founder Doug Cruikshank. “The first question a CFO will have is, ‘When do I have to pay this back? Is it first dollar out, or is there some flexibility?’”