DC Discusses Q&A: The use of fund-level financing solutions to help GPs navigate a challenging market environment
Date
6 min read
As a follow up to our previous DC Discusses feature, The revolution at hand in the alternative asset management industry, our US GP Strategic Advisory co-leads, Hal Ritch and Donato de Donato, discuss the macro headwinds impacting the alternative asset management industry, and how fund-level financing solutions can be used to help alleviate many of these pressures.
Topics discussed include:
- Impact of the current macroeconomic environment on the alternative asset management industry
- Overview of fund-level financing solutions available to GPs
- Use cases in today’s economic climate
DC Discusses examines major trends influencing the alternative asset management industry.
Q: How has the current economic climate impacted the alternative asset management industry?
The current macro environment has created several headwinds for the alternative asset management industry - probably the most widely discussed of these headwinds is the significantly more challenging fundraising environment.
- Lower valuations in the public markets have created a denominator effect, causing some large LPs to curtail commitments to alternatives in order to stay within their targeted asset allocation.
- Depressed valuations have also delayed exits and associated distributions, creating liquidity constraints for LPs and exacerbating the fundraising difficulties.
- LPs and GPs alike are feeling the impact of delayed distributions on their ability to fund capital calls, which have continued despite the decrease in realizations.
Q: What solutions are available to GPs to help combat these industry headwinds?
There are a variety of strategic alternatives, both at the GP/management company-level and fund-level, available to GPs that can help mitigate the challenges of today’s market.
In this article, we will focus on financing solutions at the fund-level. For additional detail on GP/management company-level transactions, see our previous piece, The revolution at hand in the alternative asset management industry.
At a high level, fund-level financings can be used by GPs to help offset liquidity constraints facing their LPs without having to sell portfolio companies at today’s valuations. By collateralizing the net asset value (NAV) of all or a subset of portfolio companies, GPs can raise capital at the fund that can be used for:
|
Uses of Proceeds |
Benefits |
|
Distributions to LPs
|
· Accelerate liquidity to LPs for portfolio rebalancing, funding of capital calls, and/or future fund commitments · Increase return metrics, such as IRR and DPI (distributions to paid-in capital) · Reduce the pressure on GPs to sell assets prematurely, allowing them to optimize exit timing based on market conditions · Allow LPs to retain upside, which would not be the case in a secondary sale
|
|
Growth capital to support bolt-on acquisitions and/or other strategic initiatives for portfolio companies
|
· Limit additional capital calls to LPs · Delay fundraising for the next fund until fundraising market conditions improve · Support growth for assets in mature funds with limited dry powder |
While these financings have existed for many years, we have noticed fund-level financings gain the spotlight as a potential solution to the headwinds facing the industry. In many ways, the current market environment has acted as a catalyst for its growth and maturation, driving increased deal activity, new market entrants and creative solutions.
Q: What are the different fund-level financing structures available in the market?
While each transaction is very bespoke and tailored to the specific needs and objectives of each situation, at a high level, fund-level financings can take the form of waterfall preferred equity, debt, or a combination of the two. Below is a high-level comparison of key terms:
|
Key Term |
Debt/NAV Loan |
Waterfall Preferred Equity |
|
Loan to Value (LTV) |
Up to 20% |
Up to 50% |
|
Collateral Base |
Requires more diversification than preferred equity structures |
Requires less diversification than debt structures |
|
Maturity |
~3-5 years |
None |
|
Cost of Capital |
Mid to high single-digit spread* |
Mid-teens target return |
|
Covenants |
Customary covenants |
None |
* Cost is dependent on structure and LTV. Low LTV structures (<10%), provided by traditional banks, can be priced at low single-digit spreads.
Q: How do fund-level financings compare to secondary transactions?
Fund-level financings and GP-led secondaries can be used to achieve many of the same objectives, such as LP liquidity, flexibility to hold assets for longer, and can provide fresh capital to support the growth of portfolio companies. Despite the similarities, there are a few key points of differentiation:
- Fund-level financings are non-dilutive in nature
- For LPs seeking liquidity, fund-level financings can provide accelerated distributions while still allowing LPs to retain the upside – effectively, creating a hybrid solution between selling LP interests and rolling proceeds into a continuation vehicle (albeit the amount of liquidity generated is generally lower in a fund-level financing than a secondary sale)
- Fund-level financings can be an attractive alternative to secondary sales, especially when pricing in the secondary market is down. For example, an LP could theoretically advance up to ~50% of NAV (plus retain the upside) in a financing, versus selling its interest at ~80% of NAV in a secondary sale in today’s market
- Issues related to conflicts of interest and alignment tend to be less of a focus in fund-level financings than in GP-led secondaries
While historically viewed as alternatives to one another, recently we are seeing NAV loans be combined with continuation vehicles to provide leverage and bridge an equity gap.
Q: How do LPs view fund-level financings?
As fund-level financings have become more commonplace, familiarity and comfort among the LP universe have grown. LPs understand the merits of these financings and the potential value they can provide, so much so that some LPs are using the same structures to finance against their LP interests (as an alternative to an LP-led secondary).
Since these financings are highly bespoke, they can also be structured to only include the collateral of certain LPs, in situations where some do not wish to participate in the financing.
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