Leverage at the fund level as opposed to portco level
The question might be retarded but hey, that's what WSO is for
We know that using leverage in the context of a buyout (i.e., at the portco level) gives the PE fund more firepower in terms of absolute capital amount that can be deployed for the acquisition and offers a better returns profile vs. using 100% equity.
Now, let's imagine a growth equity fund that wants to enhance its returns. The companies it buys into are not good LBO targets given lack of cash flow and smaller ownership stakes. However, being a late-stage investor, the growth equity fund is confident that its portcos can achieve a liquidity event in the next 5 to 7 years, or at least knows it will be able to sell its stake at an increased valuation further down the line.
In that context, why wouldn't the fund borrow at the fund level, allowing it for instance to double its fund size (assuming 1x debt-to-equity) and lever up its investments without having to put on portcos the burden of the debt (which they wouldn't be able to service anyway)? The debt at the fund level could be secured against portco stakes, with repayment being made at the liquidity event?
There are a few evergreen funds I know of that do this. They are traditional buyout though. I think it could totally work well for some investment styles. Others not so much.
Doing it both at the fund and portco level must offer crazy leverage effect - in the case of an evergreen fund i.e. no liquidity event, would assume that they intend to deleverage the portcos at some point and then pay themselves dividends to service the debt at the fund level? If you are okay to share, which kind of assets are they buying (industry-wise)? Do you have any colour on the type of LPs that would be comfortable with that? Would assume family offices given exotic structure
Yes all LMM funds with $150m - $1b or so in AUM that raised from family offices. Traditional PE structure is actually a big drag on returns imo and can force you to sell a great company for no reason.
The evergreen fund structure is used frequently in real estate and infrastructure.
I've never heard of it in the situation that you're describing but some buyout funds will do this instead of equity capital for the first 3-6 months of ownership of a business and then replace the GP leverage with actual equity in order to juice IRR.
Phrase to google for OP is subscription lines
No that’s at the start of the investment. These are NAV lines. FT had an article. LTV is very low on it (10-15%) but can help with liquidity. A lot of UMM/MF funds do this already
NAV loans are also rising in popularity for LPs with liquidity needs.
https://www.buyoutsinsider.com/the-rise-of-nav-lending/
Interesting at the LP level for sure. At the GP level, I understand subscription-backed credit facilities (mentioned in the posts above) use uncalled capital commitments as collateral and are used in the early stages of capital deployment whereas NAV credit facilities are used after a fund has matured beyond its investment period. In both cases LTV is low and the purpose of the debt is just to provide operational flexibility as opposed to pure leverage effect.
A lot of BDCs do this. It increases their managed asset amount, increasing their management fees and their incentive fee %s are calculated on net assets, so they have an effectively lower hurdle rate and higher incentive fees.
Would you have any examples? Great if you know any publicly listed ones so I can have a look at their reports
ARCC is Ares BDC. Check the 10-K
The investment firm would also be hesitant to take on portfolio company risk at the fund level. If the leverage is at the portfolio company level and the company goes bankrupt, the fund just loses its initial investment and the loan never gets repaid. If the loan were to be at the fund level, the fund would still be liable for the loan even if the company went bankrupt. As a result, investment firms would be much more reluctant…
When I worked at an opportunistic private debt fund, we used fund-level back leverage from commercial banks. Rough averages, we’d lend up to 80% LTV at L+900ish and back lever the first 50% of that at L+300-400. Nice way to get near-equity returns with full credit protections, and the commercial banks got comfortable because they were cross-collateralized across the portfolio.
Let me preface this by saying I’m not in PE and work at a firm that does esoteric, illiquid investments. The lack of consistent cash flow at the asset level is the main reason we use fund level leverage. We typically write smaller equity checks vs. most PE firms and therefore have many more investments. So it’s easier for us to manage flexible, fund level leverage that’s partially underwritten to our ability to generate liquidity in aggregate vs. on individual assets.
The only tradeoff is that we could probably get a bit more leverage in total by focusing efforts to get a bunch of tiny asset backed loans. However, we don’t do that due to the associated complexity and the fact we don’t actually need more leverage.
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