Fund finance crash course: from subscription lines to NAV-based facilities

Fund finance refers to a range of financial products designed to support private investment funds, such as private equity, real estate, infrastructure, and venture capital funds. These instruments help fund managers optimise liquidity, manage cash flows, and execute investment strategies without over-reliance on investor capital calls.

SUBSCRIPTION LINE CREDIT FACILITIES

A Subscription Line Credit Facility is a revolving loan secured by the uncalled capital commitments of a fund’s investors. Commonly used in private equity, real estate, and infrastructure funds, subscription lines provide liquidity in the early stages of a fund’s lifecycle, enabling managers to execute investments without waiting for capital calls. These facilities are the most prevalent form of fund financing both in Sweden and globally.

Key Components of a Subscription Line Facility:

Security Package:

• Uncalled Capital Commitments: A pledge over uncalled capital commitments, including the right to issue drawdown requests, ensuring repayment through investor contributions.
• Bank Accounts: A pledge over accounts designated for capital contributions, ensuring control over cash inflows and perfecting the pledge over the capital contributions.

The security is described as “upwards-looking,” relying on uncalled capital commitments rather than the value and performance of the fund’s investments.

Structure:

• These are typically structured as revolving loans, allowing the fund to borrow, repay, and re-borrow up to the agreed limit during the facility term.
• Loan tenors are generally short, often between 1–3 years, aligning with the fund’s active investment period.

Purpose and Benefits:

• Bridging Investments: Bridges the gap between acquiring assets and collecting capital from investors.
• Administrative Simplicity: Reduces the frequency of capital calls, simplifying operations for both managers and investors.
• Liquidity Assurance: Ensures funds can act swiftly on investment opportunities.

Investor Creditworthiness:

The lender evaluates the creditworthiness of the fund’s investor base to determine the borrowing base and facility terms. This involves reviewing investor agreements, subscription agreements, and side letters to ensure no restrictions on capital commitments or lender rights.

End of Availability:

As funds mature, subscription lines become less relevant. The borrowing base shrinks as capital calls are made, and once the investment period ends, the fund can typically no longer make capital calls.

Transition to NAV Facilities:

When uncalled commitments are exhausted, or the investment period concludes, funds may consider transitioning to NAV-based credit facilities. These facilities utilise the value of portfolio investments to provide liquidity for distributions, portfolio support, or refinancing.

NAV-BASED CREDIT FACILITIES

NAV-based Credit Facilities provide liquidity by utilising the value of a fund’s portfolio investments. Unlike subscription lines, which rely on uncalled capital commitments, NAV facilities are secured by the value of the fund’s holdings. These are particularly useful for mature funds, where the investment period has ended and capital calls are no longer an option. NAV facilities can also co-exist with subscription lines in hybrid structures.

Key Components of a NAV-Based Facility:

Security Package:

Tailored to the financing and fund structure, including:

• Cash flows and distributions from investments.
• Equity interests in holding companies or portfolio companies.
• Proceeds from portfolio sales or liquidations.
• Bank accounts receiving the above-mentioned cash flows.

The security is described as “downwards-looking,” relying on the value and performance of the fund’s investments rather than investor commitments.

Structure and Tenor:

• NAV facilities can be structured as term loans or revolving credit facilities.
• Loan tenors are typically longer than subscription lines, reflecting portfolio maturity and lifecycle.

Purpose and Benefits:

• Liquidity for Mature Funds: Provides cash for distributions, add-on investments, or operational expenses.
• Portfolio Support: Facilitates liquidity for distressed portfolio companies.
• Exit Facilitation: Assists with financing secondary transactions or managing continuation funds.

Asset Valuation:

Borrowing capacity is tied to the fund’s NAV, necessitating regular and accurate valuations.

ESG FACTORS IN FUND FINANCE

The increasing focus on ESG (Environmental, Social, Governance) factors has driven the rise of green, social, and sustainability-linked loans (SLLs). These products promote environmental or social impacts by tying loan terms to sustainability targets. However, their integration into fund finance introduces challenges:

Green and Social Loans are tied to specific projects and uses, which may conflict with the diversified strategies of funds.

Sustainability-Linked Loans (SLLs) allow greater flexibility, but require measurable ESG criteria across diverse portfolios, increasing complexity and operational burden.

Additionally, the short duration of fund investments and facilities often misaligns with long-term ESG goals.

CONCLUSION
Fund finance is a valuable tool for private investment funds, supporting liquidity and flexibility throughout the fund lifecycle. Subscription lines are critical during early stages, while NAV-based facilities are pivotal as funds mature. Incorporating ESG-linked structures adds alignment with sustainability objectives but requires overcoming practical challenges. As the market evolves, innovative solutions may bridge these gaps, better aligning sustainability goals with the diverse needs of fund managers and investors.