pfm’s recent coverage of fund finance has examined facilities provided at what might be termed the ‘front end’ – namely, those that lend against the creditworthiness of undrawn LP commitments to allow GPs to access capital (and do deals) faster than they would be able to through the laborious process of capital calls.
Recent conversations with pioneering fund-structure lawyers have revealed a more nascent financing trend at the back end, by which GPs can shift deal proceeds more swiftly into the hands of their investors.
For various reasons, it can take months for investors to be paid their dues. It could be simply down to the complexity of a deal structure, with the money having to move through a number of layers put in place for tax efficiency reasons; or a given transaction is subject to regulatory clearance.
But in situations where there is a high level of confidence that the deal will complete – and the proceeds are effectively guaranteed, therefore – a fund facility can be used to enable LPs to be paid immediately, with the eventual proceeds paying off the facility.
This back-end fund financing has brought a new method of providing security for those supplying the facility. Whereas at the front end the facility is secured by undrawn LP commitments (a safe bet due to the creditworthiness of the LPs), back-end financing may be secured against a portfolio asset or collection of assets.
Reliance on this type of security is especially likely where much of the fund has been invested and there are no longer sufficient undrawn LP commitments to provide the required security. Some fund financing experts are now talking about the possibility of either ‘looking up’ to the creditworthiness of the LPs or ‘looking down’ to the underlying assets.
There are two obvious advantages in back-end fund finance. For the investor, it means getting the capital back faster than would otherwise have been possible and the ability to quickly re-deploy it. For the fund manager, it means improving the internal rate of return – in situations where fund finance is used both at front and back, the IRR benefit is enjoyed twice.
Despite this, don’t expect the new fund financing technique to become ubiquitous any time soon. For one thing, sources tell us that some (though far from all) limited partnership agreements relating to current funds appear to prevent its use.
Furthermore, some GPs are more sensitive than others to the negative perceptions of fund finance. Given that it has been referred to in certain quarters as little more than a financing trick designed to boost returns and fees, the need for one such facility may be a sufficiently challenging argument to make to LPs – doubling up could be a step too far, however much the LPs themselves may stand to benefit.