08 April 2020
Subscription-backed credit facilities have become a widely used tool for private markets fund managers. The current crisis, triggered by the COVID-19 pandemic, has exposed some weaknesses, but also strengths of subscription lines. Over the more than a decade long bull market, managers have gotten used to the cheap and easily available source of financing. However, managers have also realized that their availability is relatively short-lived and tends to end after a fund’s investment period. In the current market environment, financing is not needed to massage IRRs of new investments, but to manage existing portfolios through the crisis. Hybrid and NAV facilities might be the most competitive source of liquidity that managers need in the current turbulent times. The below should serve as a high-level explanation of what hybrid facilities are, as always, devil lies in the detail.
Subscription lines vs Hybrid facilities
The hybrid credit facility provides managers with the best of both worlds. It provides for a guaranteed and relatively simple and attractive source of financing similar to plain-vanilla subscription lines but is available throughout a fund’s term, similar to NAV facilities.
For standard subscription lines, the utilization timeline is limited by its security package. Unfunded commitments and access to subscription lines linearly decrease over a fund’s investment period, after which managers will not have access to this attractive source of financing.
In contrast, the hybrid facility extends the utilization timeline by broadening the security package beyond unfunded commitments, adding the fund’s portfolio / assets. As such, the security package of a hybrid facility evolves along the fund – from unfunded commitments to portfolio NAV.
Like the bull market, also a hybrid facility has to come to an end. As the covenants will define diversification and LTV thresholds, hybrid facilities terminate before a portfolio is ramping-down and the diversification and portfolio NAV gradually decrease.
Similarly to subscription facilities, hybrid facilities should be used as a short-term fund financing and cash management tool. In the current situation, the majority of managers will use such facilities to support their existing portfolio companies and ease the wave of capital calls their LPs are currently facing (some will appreciate). Traditional purposes remain relevant, such as bridging investor distributions and pre-financing add-on investments.
Terms and mechanisms
- Pricing : Premiums to subscription lines need to be expected. The facility size, term, LTV level and portfolio diversification will define the final pricing.
- Security : Unfunded commitment and bank account pledge.
- Diversification : Specific thresholds apply, but facilities can also be set-up as deal-by-deal vehicle
- Loan-to-Value : More conservative than subscription lines.
- Term : Terms of 2-5 years that are extended annually. Outstanding loans are usually rolled quarterly
- Information undertakings : The more granular and recurring (i.e. monthly) the reporting, the better
- Draw-down mechanism : Similar to subscription lines, although certain types of hybrid facilities require lenders to check and approve that covenants are met prior to each draw-down.
The set-up of a hybrid facility is complex and involves more than simply negotiating a term sheet. Hybrid facilities are by nature evolving and a strong understanding of the facility’s purpose and on-going needs is crucial to design the most efficient facility and source the adequate lenders. The manager’s entire fund platform – its existing fund terms, regulatory environment, LP-base, operational set-up and investment strategy are a crucial aspect to design the most efficient credit facility. To minimize costs, the set-up process and stakeholder management should be streamlined.
Ganryu Capital Partners provides tailored and turn-key structuring solutions to swiftly implement or optimize your private market funds and global credit facilities at the best execution price.