Subscription credit facilities, which provide a debt financing source for PE funds secured by investors’ capital commitments, can be a useful tool to address liquidity needs & provide short-term bridge financing in advance of a capital call. A recent Prequin report surveys the state of the market for these credit facilities. Here’s an excerpt from a segment written by Fitch’s Meghan Neenan that lays out some of the potential issues associated with a fund manager’s decision to draw on a subscription facility:
Subscription facilities can also accelerate the recognition of incentive income for the manager in an upside scenario, as LP capital calls can be delayed and investment returns can be generated on borrowed money, leading to higher IRRs which can put fund returns over high-water marks sooner in the fund life. Earlier investment ‘wins’ may lead some investment managers to realize incentive income sooner in the fund life, increasing the risk that those returns could be clawed back (returned to LPs) at a later date if fund investments ultimately underperform expectations. Additionally, there is a borrowing cost on the subscription facilities (albeit modest) that is borne by the funds which can make mediocre fund returns look modestly worse.
The report notes that if LPs don’t understand these cost & incentive dynamics, the fund sponsor’s reputation could suffer and may make it more difficult to raise capital in the future.
-John Jenkins, DealLawyers.com July 24, 2019
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