First up: Check out this very timely video interview with Hark Capital’s Doug Cruikshank. Cruikshank talks about net asset value lending and what it might be able to do for funds during a downturn. Indeed, NAV lenders generally seem pretty upbeat that, after an initial slowdown in lending as people wrap their heads around this crisis, NAV lending for the purpose of recapitalizing investments or seizing new opportunities is likely to see a significant bump in activity.
Coming from a banking and debt capital markets background, I tend to think of solvency when I think of pension funds and insurance companies (so do regulators, hence Solvency II in Europe). And of course not all LPs are pension funds and insurance companies, but still, as Alex Lynn from Private Equity International writes:
“Institutions such as underfunded pensions could face a liquidity crunch in the coming weeks and months following a rout in the public markets and slowdown in private market exit activity.”
Basically, all financial crises are, in the instance, liquidity crises – the global financial crisis no exception; from Lehman Brothers to Northern Rock, the point of actual crisis manifested as a liquidity crunch. And liquidity is a concern, broadly – why some private equity firms are reportedly telling their portfolio companies to draw on credit lines. In the case of LPs, I’m not sure it represents a crisis in the larger sense, so much as a highly undesirable potential set of defaults on capital calls that lead to highly punitive results on those LPs existing investments, among other things.
But also, you might see some selective defaults. For funds nearing the end of life, brand new ones or funds with low quality managers, some potential threat of selective defaults by LPs could be a real one.
Alex Lynn writes that as the result of the general threat of an LP liquidity crunch, many GPs are at least considering paying down credit lines early, in case their LPs face liquidity problems. Read his story to get further details (link above).
There could be a host of reasons (beyond those mentioned already) to consider this. Maybe you’ve got a high-net-worth individual investor in a country or area badly affected by the crisis. Maybe your subscription line doesn’t have a term saying that if you default, the bank can go after the LP itself (not sure how many sub lines don’t have these terms, nor why the bank would have a better collection rate – let me know if you have thoughts).
And yet the thought of early capital calls to pay off lines hasn’t occurred to all GPs. One CFO told me today they hadn’t even considered LP liquidity and thanked me for giving them “something else to keep me awake at night.” Depending on your firm’s situation, there may be other means of dealing with a potential default – make a loan from the management company to the fund, for example.
So, are you worried about this (now?) How are you dealing with the idea of an LP liquidity crunch? I’d love to hear from you
Email prepared by Graham Bippart