Lending to Funds -- Subscription Finance Part II
Part one of this topic covered what subscription finance is, (loans to a fund secured on the undrawn capital commitments of its investors), and how it can benefit funds and their investors (increased liquidity, returns and simplicity). This final instalment covers (briefly) the mechanics of this type of financing.
How does it work?
The subscription finance facility would work the same way as a standard loan facility. As security for the subscription finance facility, the lender will be granted a power of attorney from the fund’s general partner (the GP) to step into its shoes and make the capital call to the investors, and/or an assignment of the right to make the capital call and to receive the proceeds of the capital calls. Finally, there will be a charge over the bank account into which the capital commitments are paid into.
As the fund purchases its investments, it makes the calls on its investors whose commitments are used to repay the subscription facility, so the investors' capital has ultimately been used to purchase the funds' assets. Or the fund could refinance using a facility secured on the assets purchased with the monies advanced under the fund’s subscription facility. In the unlikely event that the fund falls into difficulties, the lender can step into the shoes of the fund’s GP and make the call to the investors. It can then use those proceeds to satisfy the outstanding loan or other obligations (if the uncalled capital is being used to guarantee other obligations of the fund).
What should the bank/ financier and the fund look at?
- Does the fund (and its GP) have the ability to borrow money?
- Can it grant security? Are there any limits on the ability to grant security and borrow money?
- Does the GP have the power to make calls on the undrawn capital commitments?
- Can the GP require non-defaulting investors to make up the shortfall created by defaulting investors?
- Are the capital call notices “bullet proof”? There should be no wriggle room to justify a non-payment of the capital (not that this should be an issue if the relevant fund documents have been drafted by an experienced funds lawyer such as those at Harneys).
- Finally, the investors (to whom effectively the lender is lending to). What is their credit worthiness, do they have immunity, where are they located and what is the cost of enforcing against them? (Remember that not all jurisdictions are as creditor friendly and accessible as the British Virgin Islands or the Cayman Islands). If the investors are feeder funds, then the lender will need to go up the chain to find the entity with the money, looking to tie in each entity in the chain as it goes through the feeder funds and making sure that there are no gaps in the chain where the monies could fall through.
Why the British Virgin Islands or Cayman Islands?
You might have heard this before, but both jurisdictions are well established and tested in providing relatively straight forward enforcement for creditors (and in particular, secured creditors). They also have the benefit that they recognise “foreign law” documentation and so a lender could reduce costs by using its own standard documentation with minimal amendments. Or alternatively they could use BVI or Cayman law documents, efficiently and inexpensively drafted by Harneys.
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