Subscription line facilities, a stable financing tool

Subscription line facilities also known as capital call facilities are credit facilities used by a fund to bridge investors’ capital calls during its investment period. This financing is subject to a borrowing base determined by the value of the investors’ available commitments satisfying certain eligibility criteria. Subscription line facilities are described as “upwards looking” financings given that the lenders focus on the creditworthiness of the investors and the legal robustness of their available commitments towards the fund. The security package is comprised of:

  • a pledge by the fund of its rights under the uncalled investors’ commitments and the claims against the investors in relation thereto, and
  • a pledge over the bank account dedicated to investors’ capital contributions.

This financing tool is now essential to the operating business of fund managers and despite the slowdown in fundraising, the collapse of certain fund finance lenders and the surge in interest rates, subscription line finance remains a key tool for investment fund managers.

A new fund finance era with NAV facilities

Outside of subscription finance, NAV facilities have emerged as another key source of financing to address the liquidity constraints faced by managers in the current economic climate. NAV facilities were traditionally used by debt and secondary funds given their relative liquidity but are now frequently used by investment funds investing in all asset class types. These facilities allow fund managers to borrow based on the value of their portfolio investments, providing them with flexible and efficient access to additional capital and allow them to generate liquidity at the NAV of the portfolio, rather than at a potential discount on the secondary market. NAV facilities may be used in various situations, to address liquidity constraints or drive value creation. Particularly when the undrawn investors’ commitments are low or the fund investment period has ended and the fund seeks liquidity for working capital, investor distributions or add-on investments or, to provide additional liquidity for their distressed portfolio companies. For continuation funds, NAV facilities are used to finance the exit of limited partners not rolling-over.

Typically, NAV facilities are structured as term or revolving loan facilities made available by lenders to a fund or a special purpose vehicle (SPV) held by the fund. Contrary to the subscription line facilities, NAV facilities are described as “downwards looking” financings as lenders have recourse to the value of the portfolio investments of the fund. The borrowing base is calculated on the net asset value of the eligible assets of the fund. The security package depends on various considerations, notably:

  • the fund’s investment strategy and its portfolio investments,
  • the borrowing structure, and
  • regulatory and tax matters.

Depending on such considerations, lenders may seek recourse to, notably:

  • the bank account on which the distributions made by the portfolio investments are received,
  • the distributions claims owed by the portfolio investments, and/or
  • the equity interests/ shares in a holding or portfolio company.

Where the borrowing entity is the SPV and not the fund itself, lenders might require the fund to grant a pledge over its equity interests/ shares in the SPV or to give a guarantee or other types of credit supports. The aim is to allow the lenders to control the underlying assets and/or distributions paid on such assets.

A Careful analysis of constitutional documents required

In respect of the legal due diligence process, an assessment of the constitutional documents must consider the specific features of the NAV financings and should be focused on the structure related to the portfolio companies hold by the fund. The constitutional documents of the fund (notably the limited partnership agreement or equivalent) or the SPV should be carefully reviewed, with a particular focus on:

  • the possibility to use leverage and to grant security interests,
  • the borrowing/ indebtedness limitation,
  • the permitted duration for borrowings and other indebtedness, and
  • the use of proceeds.

Certain regulatory matters should be considered in relation to NAV financings as such financings may constitute leverage under the Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers (AIFM), as amended, and the Luxembourg law of 12 July 2013 on alternative investment fund managers, as amended.

Hybrid products on the rise

It is worth noting that hybrid products combining subscription financing features and NAV financing features are gaining popularity among fund managers seeking for a single financing available through the fund’s life cycle. Evergreen funds (which are open-ended fund structures with no termination date) can particularly benefit from hybrid financing to achieve their long-term liquidity needs.

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