Leverage for Co-Invest?
Anyone have insight on what's typical at the VP+ level? Specifically looking for general terms e.g., amount loaned vs. commitment, interest terms (PIK, forgiveness at exit, etc.), recourse, etc. I've heard a pretty broad range (everywhere from no leverage to 80% LTV, with the average appearing to be ~50%) so would be good to get a sense for what people are seeing.
$500k line from third party, ~70% LTV, discount to prime, 5 year tenor
$180K line from third-party at prime + 25 bps; 60% LTV, interest only with straight line pay down starting at 5 years; min of 60% of all distributions go to pay down the line until 100% paid off.This is as an associate, and the loan amount was capped by lender due to my salary, not capped by the fund
What’s the third party for this?
Just remember this is leverage on leverage and this is all recourse to you so make decisions wisely.
mine is only recourse to other coinvestments funded with the line. no other personal assets at risk.
How do people think through the risks here? I’m joining a fund shortly that lets us co invest ~250k with leverage. I certainly don’t have $250k laying around, so would be heavily levered to “max” this option (which is allowed).
Personally, taking out $100k of leverage (on an already levered investment) seems a bit insane. I’m joining a reputable UMM so obviously chances of going to 0 are slim, but seems a bit risky to put all of my eggs in this single basket (considering if the fund theoretically went bust I’d be jobless as well as in debt). I’m sure in 08 there were some associates that were underwater on their levered coinvest?
Could you invest through an LLC?
Banks would still require a personal guarantee for the loan.
Highly unlikely your shop blows up to the point of turning in a sub-1.0x MOIC. Worst case, assets get fire sale’d and it repays your loan to zero. Borrowing at 4% vs. the cost of your own equity capital (call it 7% p.a. return on public equities) seems like a good trade
It’s a very valid question and I had the discussion with several junior and mid-level people in the industry.
Below, I will first outline my current situation and then my thinking around it as you progress your career.
I am currently at a fund and get an all-cash comp every year (no carry) with the option to co-invest up to a maximum amount. There is a form of bridge loan provided by the GP to the next bonus, i.e. any capital calls in the year leading up to the next bonus can be funded with the expected bonus to come.
I decided to commit as much capital as I can reasonably expect to fund from my Associate 1-3 bonuses after taxes plus the savings I had from my banking years. As a result, I am long the fund more than my current net worth. Rationale behind this was quite simply: if I can turn ~$400-500k into 2.0-3.0x by the time I am in my early thirties, it gives me significant freedom. If it goes wrong, I still have the option to continue my career in finance.
As you progress your career, your financial relationship with your employer will intensify in terms of significance. You will continue to get your cash comp from them but will also have material carry and co-invest in the firm. Depending on your risk appetite, a lot of people then decide to hedge their exposure by putting some of their net worth into real estate and stocks (oftentimes trying to diversify the investment strategy of their GP; think investing in growth stocks while working at a value PE fund).
In terms of applying leverage to your co-invest, the terms are oftentimes so attractive that you might want to consider it but you need to structure your personal finances accordingly and need to review the structure.
I have commonly heard of 75% LTV on co-invest, meaning you only turn 25% of the capital calls. I have come across two types of calculations for the LTV:
(I) cost basis: there is no impact of current marks and the only condition is that all distributions go to forward loan repayment until your loan for that fund has been fully repaid
(Ii) current marks: if your investments get marked up, your leverage ratio goes down and you can actually fund additional investments with less than 25% equity as you only need to get to 25% on a portfolio basis; however, if marks go down as experienced in Q2’22 or during the Q2’20, you will get a margin call to get your equity up to 25% LTV; this poses a material liquidity risk for you especially as lower marks are oftentimes seen when stock markets crashed, reducing the value of any stock portfolio you held on the side; this set-up had caught some PE folks off guard in the GFC and led to some personal bankruptcies although their funds ultimately returned >1.0x MOI
Definitely not the worst case…
Are you all insane? These deals could have 6 turns of debt on them and you want to juice them even further? It's not like you're investing in 20 companies but a single business. Wake up.
1. Yes
2. Yes
3. No
Bizarre comment. We're talking about applying leverage to our equity co-invest across multiple platform investments. If you have confidence in your firm's ability to generate returns, and you're relatively young in your career, why wouldn't you apply modest leverage to your co-invest? Even at a 1x total return where 50% of your portco investments go belly up and 50% hit 2x, you're still going to come out ahead on your equity because of that leverage.
Financial leverage is one of the largest causes of deal failure. Lots of people use leverage cause they can't come up with all the cash. No idea why you'd want to juice it even further.
It's leverage on leverage you childreb. Come to me when you've lost the few hundred K you're putting in.
lol - please, nobody work for this clown of an independent sponsor.
What? At the dollar scale and wealth level most mid-level staff are investing with (which you're demeaning here), moderate leverage often makes a lot of sense.
We get non recourse leverage I.e. you at most lose what you put in and it’s 2.5:1 but rate is higher
Yep
I’d rather take this kind of risk with an asymmetric return profile (>4x levered MOIC if it works, 0.5x if it doesn’t) vs. owning some equity in a crappy 10-person startup
How are y'all thinking about leverage conceptually in this context? If you have sufficient funds why would you take up leverage on your co-invest? Your opportunity cost of capital are likely lower than the targeted 15%+ IRR from co-invest, so why not funding the whole co-invest with equity if you can? To the guys who are taking up leverage, why do you do it? Because the co-invest goes above your total net wealth? In which case you'd be in deep trouble if the fund actually were to go belly up (even worse if you do deal-by-deal co-invest)?
Different risk profile, but Secondary here - can in theory lever whole LP commit to fund assuming early distributions (net called unlikely to go over 55-60%). Very well diversified across managers/industries/vintages, etc...
You sure you work in PE? You use leverage because the 15%+ IRR is greater than the cost of debt (call it 5%)… whether you choose to put those extra funds to work in SPY at a diversified / liquid 7-8% IRR or back into the fund at a locked-up, concentrated 15% IRR (or real estate, debt, whatever) is a separate decision
That does assume your alternative (SPY / diversified portfolio) generates reliable returns higher than your 5% cost of debt, and that post-tax. With interest rates increasing that 5% will probably be higher too. So you really need to achieve 8%+ returns pre-tax just to break even, so you’re playing on the upside above that - which likely won’t be more than 2-3% higher in the long-run and offsetting against the risk that SPY returns could indeed come out lower.
If your usage of the freed up capital is upping the co-invest then it goes to the other part of my question about being comfortable investing more than your total wealth into this (assuming taking it to the extreme)?
So my point still stands or am I missing anything (genuine question)?
It looks like most of you have a set figure for the entire fund life. But how much on average are you deploying each year? I would estimate around 200k per year for me.
Clearly none of you guys have heard about the VPs at softbank that were pushed to have a significant amount of levered co-invest (we are talking $m) that is now deep underwater and they are personally liable.
Any career in finance will be lucrative enough that you don’t need to put yourself at risk for such silly things.
PE has done really well over the last 10-12 years because of a very favorable environment, I would not be running with the same assumptions going-forward.
My leverage line is only recourse to my coinvestments. No personal liability outside of that.
We set up a program that is 50% LTV, prime plus 50, interest-only, fixed cost basis, non-recourse. Had to guarantee the line with the GP entity, but was comfortable given the carry vesting schedule and buyback in place.
Is it common, in your experience, for funds to offer this kind of profile for a GP buy-in (secured against carry) and then, separately, offer favorable leverage terms for deal-by-deal coinvestments? I would imagine latter sits behind former with a lien on carry and/or recourse but I'm also kind of a moron. Asking because my partners (admittedly rather boozed up, thus my confusion) seemed to allude to allowing both and I would like to not look like a complete idiot when I broach it with them when they're sober.
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