“Despite some negative noise we heard in the market around capital call lines, the reality is, a lot of LPs expect them to be used”
Samantha Hutchinson, Cadwalader
Long gone are the days of CFOs and FDs being viewed as simply cost centres. The recent explosion in fund financing and related debt products enables today’s finance leaders to assume a prominent role on both the firm’s strategy and value creation within the portfolio.
Subscription lines are nothing new but have certainly moved into the mainstream in recent years. Given the private nature of these loans it’s difficult to put an exact number on the size of this market, however, law firm Cadwalader estimates it’s now worth more than $500bn with lender commitments increasing by 20% in 2019. Says Samantha Hutchinson, fund finance partner of Cadwalader, “Despite some negative noise we heard in the market around capital call lines, the reality is, most GPs now use some form of fund financing and a lot of LPs expect them to be used.”
With greater acceptance of capital call facilities, a new market has sprung up offering variations on the original product. This growing range of options, if used strategically, can act as a powerful set of tools for CFOs to deploy however needed, whether that be serving LPs, boosting profitability or increasing flexibility throughout the structure.
When it comes to raising capital, historically IR heads have overseen the expedition, mapping out the market, pitching to investors and creating data rooms. CFOs are vital components in the process by readying track record data and acting as a valuable source of expertise when it comes to technical questions on how the platform is managed.
However, a shift is taking place, driven by fund finance. With LPs expecting these facilities to be adopted, CFOs must take the lead in lining up lenders, lawyers and legal documentation to support the fundraise. By doing this CFOs have a natural opportunity to showcase their expertise and vital role in managing a robust platform, in a proactive rather than reactive way.
Says Gavin Rees, head of SVB’s global funds banking team in the UK, “Responsible use of fund financing is something LPs want to see; it adds to the justification of commiting to a fund. So if you’re savvy and you know the terms, and you know what your peers are doing, then that’s of value. It’s about being knowledgeable, which is an integral part of how a fund works today.”
From an operational perspective, securing the subscription line in a considered manner can save a great deal of time and money. “When the documents are first put in place, usually it’s the CFO agreeing the terms of the fund finance but someone else overseeing the LPA, which can lead to fixes needing to happen after the fund is closed and potentially at a large cost. CFOs can prevent this by working with the fund counsel at the documentation stage,” explains Hutchinson.
Not so silent partner
A key driver in the popularity of fund finance is the smoothing of capital calls, easing the administrative burden on LPs and allowing for better cashflow management. Conversely, the main criticism levelled at these facilities has of course been their ability to inflate IRRs. But herein lies another opportunity for CFOs to strengthen relationships with investors. “It’s vital to communicate to LPs on the usage and size of the facility, as well as the regularity of clean downs,” says Hutchinson. “A preparedness to demonstrate to LPs how returns are being impacted; to show what the IRR looks like without the facility should be top of mind for CFOs.”
“The most sacred relationship is with your LPs,” says William Lamain, director of funds finance at Raiffeisen Bank International. “And if fund finance was just about boosting your IRR, LPs would see through that.” CFOs can turn this on its head by proving their professionalism and high levels of service. “There needs to be transparency throughout,” says Rees. “Don’t be troubling LPs with requests, it should be purely notifications.”
Beyond the bridge
Perhaps the most important aspect of a fund finance facility is the advantage it gives GPs when transacting. The ability to quickly deploy capital can, in some cases, make or break a deal. Yet the power of these facilities stretches far further. For multijurisdictional vehicles, managing FX can be painful. For example, a pan-African fund denominated in USD, would drawdown in USD and then have to convert to the local currency, which could cause material losses. However, with a fund facility, a CFO knows exactly how much USD the fund has on any given date and can therefore forward plan the currency swap.
A facility also caters to the uncertainties often involved with investing. “You don’t always know what the final equity cheque will be; there might be a co-investment piece or some changes to the final terms which impact price, so a facility allows you to close the deal on the subscription line and sort out the equity afterwards,” points out Colin Baker, partner in Reed Smith’s financial industry group.
Furthermore, funds using bridging facilities are able to secure better terms on financing for their portfolio companies post-acquisition. “You can ramp up your portfolio and then approach lenders for asset-backed loans. The diligence is then very simple for the lender as the asset has already been purchased. The CFO can set up a dataroom with all of the documents and make the legal process far more efficient,” explains Leon Stephenson, also a partner in Reed Smith’s financial industry group.
But thanks to recent innovations for NAV facilities and preferred equity, CFOs have far greater influence over portfolio company value creation. Once a capital call facility has dried up, NAV facilities and preferred equity can be put in place as a fresher source of liquidity.
Explains Augustin Duhamel, managing partner of 17Capital, “We’re not looking at uncalled capital, instead we’re looking at the NAV of portfolio companies. It’s about increasing the firepower of the fund. It’s a strategic tool to better manage cashflows.”
And because this type of financing is separated from investor commitments, it can be used in a variety of ways. Not only can these facilities increase liquidity, thereby speeding up distributions if needed, they can also support assets not ready for exit. “Where more time is needed with the underlying assets but they’re concerned about distributions, then the CFO has to decide if portfolio companies can take on more leverage, if they can then NAV facilities can be a really useful tool to accelerate liquidity while only applying a small amount of debt on a low LTV basis,” explains Hutchinson.
“We’re also seeing NAV facilities being used on a follow-on basis where there’s no uncalled capital but there’s a need to build on existing investments, CFOs are using these loans to generate extra liquidity, which can be crucial to the success of the fund,” adds Hutchinson.
“Greater ﬁnancing options allows CFOs to ﬁnd the best option for the fund in terms of cost, resources, investor and portfolio needs”
William Lamain Raiffeisen Bank international
Of course, a major responsibility for CFOs is ensuring funds and the management company run in a secure and efficient manner. And here’s another example of where greater financing options are helping. Says Lamain, “If you’re a debt fund doing say 20 investments per year, that takes a lot of hours to administer the drawdowns. Or if you use an administrator each drawdown may be an incremental cost to the fund. Greater financing options allows CFOs to find the best option for the fund in terms of cost, resources, investor and portfolio company needs.”
Rees agrees, “These facilities can maximise your performance, not just in terms of IRR but rather in how the fund is run; to ensure effective use of time and resources. Especially for small teams and given the cost of fund administrators. In this interest rate environment no one gets rewarded for being overly conservative on debt, rather the cost of not having an effective liquidity tool is huge.”
A really recent addition to treasury management has surfaced in the arrival of fixed term funds (FTF). The creator of these products is TreasurySpring Management, whose COO and co-founder Matthew Longhurst has seen strong interest from private equity clients. “We’re onboarding a large private equity fund at the moment. First we’re working with them at the management company level with regards to fee income, with a view to also helping the underlying fund vehicles or portfolio companies, which often have surplus cash earning little or nothing. As fee income and expenditure are fairly predictable, management companies are often sitting on lots of cash with total visibility on how it’s going to be paid out.”
FTFs allow CFOs to invest in government, secured bank or investment-grade corporate obligations from a one week rolling basis, out to one year to minimise risk and boost returns. “Often GPs are sitting on large cash balances but aren’t typically set up as large businesses so don’t have access to a wide variety of cash investment options. But FTFs allow GPs to diversify away from unsecured bank risk and manage their cash in an efficient and secure manner,” explains Longhurst.
Everyday’s a school day
Clearly, as private capital markets continue to grow and mature, the fund financing space is maturing and innovating at an accelerated pace. This places greater onus on finance leaders to keep on top of new developments. “CFOs really have the responsibility to establish whether or not a particular facility is the right choice for the fund. And pricing isn’t everything, the relationship with the lenders and other terms of the facility can be equally important,” says Hutchinson.
What can CFOs and FDs do to keep on top of this rapidly shifting market? “It’s about establishing that network with other CFOs so that you keep on top of what your peers are doing,” advises Rees. “If you have trusted partners such as a bank, law firm or other CFOs, find out what they’re doing and what is acceptable to LPs. It’s amazing how the same LP can be hammering one GP on terms and not another, simply because one GP better communicated,” he adds.
But it would seem directly approaching lenders themselves as a way to keep on top of market developments can come with additional benefits. Not only is this group actively involved in the most recent developments, the relationship between CFO and lender is becoming increasingly powerful.
Given the various ways in which fund finance supports a growing list of functions - from supporting fundraising, investor relations, winning deals, executing transactions, flexibility over hold periods, providing liquidity to investors, improved economics throughout the firm’s structure, and even working fee revenues harder - lenders are wise to how crucial these facilities are to their overall relationship with the GP. While fund finance extends its remit, private equity will always need acquisition finance, as well as a whole range of products banks are all too keen to provide.
Beyond the rise in NAV-related products there has been a spate of more recent innovations. For example, last year Hutchinson worked on one of the first NAV facilities provided to a venture fund and first back levering of a preferred equity instrument .
And there have also been two instances of ESG linked products within the last six months. In October 2019, Singapore-based Quadria Capital secured the first ever sustainably-linked fund loan. The $65m three year revolving capital call facility was provided by ING and pegs the borrowing interest rate to ESG performance targets.
In January this year, Eurazeo secured a €1.5bn credit facility also linked to ESG performance criteria. Not only does this kind of financing send out a positive message to LPs and portfolio companies, there are cost benefits to be had. Philippe Audouin, CFO of Eurazeo explains, “We included a kicker, an ESG commitment, which is in the loan documentation. We have agreed to four criteria, which if we meet we will benefit from a bonus on the bank margin, and we have commited to give that bonus back to causes that work towards carbon neutrality. If we don’t, we would pay the small margin to the banks, and we have agreed that they would also pay that margin to the same cause.”
The flexibility and optionality provided through the growth of fund financing products is a game changer for today’s CFOs. Putting all of these products together, a CFO’s remit becomes far greater. This isn’t just good treasury management, these are tools that provide a multitude of levers to be pulled in an exacting a careful manner; to best serve LPs, portfolio companies and the partnership itself.
CFOs are now crucial to capital raising; in lining up lenders and documentation, as well as showcasing the firm’s expertise in running an efficient platform that caters to each LP’s unique needs. CFOs are integral allies to investment teams for providing efficient capital when needed, to facilitate refinancings and find the most economical structures for underlying assets. CFOs can further support investment teams by providing greater flexibility and optionaility over exit timing while ensuring LPs needing liquidity are provided for. And on a team basis, CFOs can be maximising fees through innovative treasury management approaches, safely and securely taking advantage of the unique structure to make cash work harder.
But most importantly, greater optionality gives CFOs an armory of devices that can be used to pursue their own ambitions. Says Reed Smith’s Stephenson, “The real value-add of financing options for CFOs is driven by their objectives, which could be maximising profit, speed of execution, getting the right deals, managing FX, or providing liquidity to LPs.”