The fund finance industry has been growing in popularity over the last few years as the products being offered have evolved.
“Five years ago, we believe roughly 50 percent of funds globally were using fund finance, while today more than 90 percent of funds are using these types of facilities,” Sarah Lobbardi, a partner and head of fund finance at Validus Risk Management, told sister publication Private Equity International in February.
Tom Glover, Investec’s new head of fund finance in New York, who has more than 30 years of investment banking experience, shares his perspective on how general partners are seeking financing and his expectations for the future of the fund finance market.
How many members does Investec’s US fund finance team have?
There are six of us right now and we continue to grow.
How much more competition do you expect in the subscription facility market?
The subscription facility world is a large one. Its growth is directly linked to the amount of new funds raised each year. The robust fundraising market over the last decade, as well as the more pervasive and intensive use of subscription lines, have led to a dramatic growth in this product area. Increasing market size has attracted a number of new entrants over time, and that trend continues. We have seen substantial spread tightening over time in the subscription facility segment, but pricing appears to be troughing.
Is your team focused on subscription credit lines?
We’re active in the subscription facility market, but our focus tends to be on the mid to later stages of a fund’s life when undrawn limited partner commitments are diminishing and are often committed to supporting existing portfolio companies, so what remains of undrawn capital is often not available to support new initiatives. Investec’s recently-released GP Trends report highlights the fact that private equity firms are increasingly seeking flexible capital to support the value creation process into the late stages of a fund’s life-cycle. In fact, 83 percent of managers surveyed are planning to make substantial investments into their portfolio companies well into the fund’s harvesting period.
To support our clients’ capital needs in the later stages of the fund life-cycle, we focus on lending against the net asset value of the fund’s portfolio. Instead of lending against undrawn capital from limited partners, we’re looking to the value of the remaining investments within the fund and their successful exits as our source of repayment. The skill sets for NAV lending are very different from those for subscription lending. For our NAV-based loans, we perform detailed bottom-up, company-by-company analysis.
What are the financing options available to GPs in the second half of a fund’s life?
Focusing on the second stage of a fund’s life, there is an expanding continuum of financing opportunities available to GPs. For example, let’s say you are a GP in year six of your fund’s life and one of your portfolio companies has uncovered an acquisition opportunity that requires substantial incremental equity. Your remaining uncommitted LP capital is insufficient for the need, so what do you do? In that situation, we would look to provide a credit facility to the fund that is structured with credit support derived from both ‘looking up’ to remaining undrawn commitments, typically provided by large investment-grade investors, and also ‘looking down’ to the fund’s assets in the ground. Because this type of structure combines aspects of both a subscription facility and a NAV facility, it is called a hybrid line.
As funds move beyond the mid-stages of life, undrawn capital tends to dwindle and even disappear. But GPs are increasingly seeking to be proactive in driving value in this later timeframe. To provide our clients with the capital resources they need at this stage of life, we provide credit facilities that are exclusively based on the fund’s assets in the ground. Frankly, this NAV financing space is where a lot of innovation is happening and we are devoting a large portion of our energies here.
What are some of the more innovative ways GPs are accessing financing, and how will that grow in the future?
Perhaps the most fascinating arena that has blossomed in recent years is the GP stakes market. This arena has been developed by firms like Neuberger Berman’s Dyal Capital, Goldman Sachs’ Petershill, Blackstone’s Strategic Capital and a handful of other players. Their strategy is to buy typically 10 percent to 20 percent ownership stakes in highly successful general partners that oversee multiple private equity funds and then help those GPs accelerate their growth. We are close to completing what we believe is the first debt financing that is a part of a GP stake purchase. It’s a massively complex transaction; I have a 30-year history of deals on Wall Street and I can tell you this is one of the most complex I’ve ever worked on.
A GP stakes transaction can provide substantial amounts of capital to a fund manager, but it involves selling equity and bringing in an outside partner. Often, a GP needs a smaller scale, less expensive capital solution. Let’s say a founding partner would like to retire and the remaining partners would like to purchase that partner’s stake. Or the GP is raising a much larger new fund and junior partners need help in funding their share of the next fund’s GP commitment. We can cost-effectively provide for those needs through a credit facility supported by the GP’s management fee streams and other assets.
What’s the fastest-growing area of activity?
By dollar amount, the fastest growing area of GP activity is GP-led restructurings of older funds. The rationales for these transactions are many, and LP receptivity to them has grown. With that, transaction volumes have accelerated to nearly one-third of all secondary market activity. A typical deal structure involves the creation of a continuation vehicle that acquires some or all of the remaining assets of an old fund. Along with fresh equity capital from new investors, we have supported the assets of these continuation vehicles with lines of credit.