Lending to Funds - an introduction to subscription finance
“Neither a borrower nor a lender be” wrote Shakespeare and in the aftermath of the credit crunch and the global slowdown, it seems that many banks are reacquainting themselves with the words of the Bard. And when they do lend, they are increasingly looking for more security, “safer” borrowers and higher fees.
On the face of it, a newly launched fund might not have the track record or the assets to persuade commercial lenders to lend monies to it. But these funds do have assets which they can make available to lenders - the uncalled capital commitments of their investors.
What is Subscription Finance?
Funds subscription finance, also known as capital call or equity bridge finance, are loans to a fund secured on the undrawn commitments of the fund’s limited partners to make capital contributions to the fund (when called upon to do so by the fund's general partner).
As an alternative to subscription finance we have also seen these uncalled capital commitments used as a guarantee for funds’ transactions such as hedging, so reducing the fees being paid by the fund.
Why do it?
- Reduced costs. It allows the fund to benefit from guarantees from its investors, without the investors having to give a guarantee or expose themselves to any additional liability than their existing uncalled capital commitments in the fund.
- Administratively easier. Instead of the fund financing an investment by making capital calls to its investors (which if the fund’s investors are feeder funds, will involve those investors making calls on their investors), the fund can make a single drawdown on the subscription facility. The fund can then make its call on its investors and use those proceeds to repay the lender.
- Increased returns. As the investors’ monies are only called when they are needed, they work harder with enhanced returns.
- Flexibility. A subscription finance lender is only "looking up" at the investors sitting above the fund, and does not compete with any other lender who would be “looking down” at the assets owned by the fund. Whereas a traditional bridge lender who is secured by all asset security over the fund's assets, usually in the form of a floating charge, will require a release of its security whenever the fund refinances specific investments.
- Simplicity. Subscription finance should be straightforward to document: there should be no covenants tied to specific assets or restrictions on how the fund uses the borrowed monies (things which are of interest to finance lawyers and credit committees, but perhaps not so much to everyone else). Although most funds will have restrictions on their investments in their fund documentation.
Liquidity, simplicity and increased returns – what more could a fund want? You can see why it is an increasingly popular form of financing.
This post is part one of a two-part series. In the next instalment I cover how these facilities work, what the bank/ financier and the fund should look at, and why (in our humble opinion) the BVI and/or Cayman is best suited for these facilities.
After all as regular readers of the blog will know, both the BVI and Cayman are excellent offshore jurisdictions with relatively sophisticated legal systems and creditor friendly insolvency regimes. So much so, that I am quietly confident that if Shakespeare was writing nowadays, then he would have reconsidered his position on the merits of borrowing and lending, but perhaps not his views on lawyers.
Of course if you want more information and do not want to wait until the next instalment of the series, then you can always contact the author directly or your usual Harneys contact.
The author of this post is no longer with Harneys. For more information on this topic, please reach out to the author listed above.