Fund Finance – Latest Market Developments

Speaker 1 (00:01): Emmanuelle Dotezac

Hello everyone. My name is Emmanuelle Dotezac from IQ-EQ, and I'm delighted to welcome you today to our webinar, where we will discuss the latest trends in fund financing. A lot has happened in the past years from sub-line to NAV financing. I am joined today by five panelists who represent the borrowers, the lenders, advisory and investors perspective. Well, I'm going to hand over to the panelists right now, who are going to introduce themselves. Thank you so much for joining us today. Sarah, would you like to introduce yourself?

Speaker 2 (00:44): Sarah Lobbardi

Yes. Hi, thank you very much Emmanuelle. And so, I'm Sarah Lobbardi. I'm the founder of Avardi Partners who are advisors specialised in the fund finance space. We help fund managers globally across a wide range of asset classes, like private equity, debt funds, secondaries, real estate, and infrastructure funds to put in place their financing needs at the fund level.

Speaker 1 (01:08): Emmanuelle Dotezac

Thank you, Sarah. Gregory?

Speaker 3 (01:11): Gregory Beauchamps

Thank you Emmanuelle. I am Gregory Beauchamps, heading the fund structuring group with Tikehau Capital with circa 31 billion Euro of AUM. We are alternative asset management and investment specialists. We're focusing on four key asset classes or funds allowing investors to achieve attractive long term returns in private debt, real assets, private equity, and capital market strategies. I work in conjunction with internal stakeholders and/or portfolio managers obviously, and we design bespoke solutions for our prospective LPs, we optimize fund structures, and we negotiate HUD financing.

Speaker 1 (01:54): Emmanuelle  

Thank you so much, Gregory. Camille?

Speaker 4 (01:57): Camille Defaye

Hello everyone. Camille Defaye here, CFO of Latour Capital. We are a French private equity fund based in Paris, and now we have 1.6 million euros under management and yes, we use a fund financing solution. Happy to discuss that today.

Speaker 1 (02:12): Emmanuelle Dotezac

Thank you so much Camille. David?

Speaker 5 (02:16): David Checoury

I'm really delighted and pleased to be part of this panel and have an opportunity to exchange with my peers in the industry. I'm David Checoury. I'm the president of Stanhope Capital in France. Our group, the Stanhope Capital Group, supervises circa 27 billion dollars in the world. We have three activities. One is private equity. Second one is wealth management and also merchant banking. Regarding private equity, we've been an investor as early as 2004, and we have established a platform of 10 funds. We are active in fund of funds in private equity and direct funds and our platform is expanding. Our clients are large families, ultra-high net worth individuals, as well as institutional investors. We operate from London, Geneva, Paris, New York, Miami, and Philadelphia. Therefore, through our platform, I would be very delighted to exchange views about the exciting developments of fund financing, both as an LP and as a GP.

Speaker 1 (03:20): Emmanuelle Dotezac

Thank you so much David. Augustin?

Speaker 6 (03:24): Augustin Duhamel

Good morning, everyone. Very happy to be with you as well. My name is Augustin Duhamel. I'm a managing partner at 17Capital. 17Capital is a dedicated specialist provider of NAV financing. We've been doing it since 2008. Today, we have 8 billion under management and we operate from London and New York with a team of 60 people. To date, we have completed 70 NAV financing transactions, either with a view to accelerating liquidity or providing more investment capacity. And we have transacted/provided financing to investors, limited partners in funds, we have worked with GPs, managers of the funds, and we have also provided financing to the funds themselves, which would be the focus of the discussion today.

Speaker 1 (04:20): Emmanuelle Dotezac

Thank you so much Augustin. Let me kick off with Sarah, asking the first question. Would you like to explain us the different options in fund financing?

Speaker 2 (04:32): Sarah Lobbardi

Sure. So, there are around six different types of financing that we see in the fund finance space, but I will focus on the two fund financing which represents over 90% of the volume of the transactions, and which I think would make more sense for the conversation. 

So first of all, we have what we call capital call facilities, also called subscription line facilities or equity bridge financing, just depending on region we are talking about. And these facilities are secured and collateralised by undrawn commitments of the funds. They are used usually to be able to bridge capital calls, and allow fund managers to call on capital through the facility instead of having to call the investors every time they make a new investment. These facilities are widely used in the markets. We believe that over 95% of fund managers are using this type of financing today.

There are very cheap financing in the markets, and they allow the fund managers to have quick and easy access to capital within usually one to two business days, which make them very reactive in the market in terms of making new investments and therefore more competitive with that kind of reactivity. It also allows them to have an operational efficiency, without having to go and call the investors and wait for two/three weeks, but being able to kind of quickly access that capital. It also allows them to obviously improve their returns by having a use of a cheap cost of capital. And finally, it's very useful to have a capital call facility where you are fundraising, which allow fund managers to be able to consolidate the calls and not have to do any equalisation between fund closing so they can draw on the facility and make one call at the end at the last close.

So that's the capital call facilities and how they’re used in the markets. The second type of financing we see that is very used in the market is asset backed financing, which is also called NAV financing. And this type of financing are used quite differently depending on the asset classes. So, for example, for debt fund managers, they are used as a pure leverage tool. So, fund managers on the debt space will raise a leverage sleeve and an unleveraged sleeve, and will put NAV financing on the leverage sleeve. This NAV financing will be collateralised by the assets in the portfolio, the future assets in the portfolio. And the purpose of this facility is really to increase the investment capacity from day one. So, they will be able to draw on the financing to make new investments at a very cheap cost of capital, improve their returns, and be able to use that line from day one.

So that's for debt fund managers. On the secondary space, which is another asset class where we see a lot of NAV financing being put in place, again, same collateral will be the assets in the portfolio, and they are usually used to do dividend recaps after the investment periods. But what has been interesting is that we have seen that in the secondary space, more and more fund managers are using these financing like debt funds from the inception while they are still deploying capital to really increase the investment capacity at a cheap cost of capital. And finally, I will cover this maybe a little bit less in detail as Augustin will be covering this subject, it's NAV financing for private equity funds. And these ones have been, I would say, representing maybe less of a volume of the deals we have seen in the market over the last few years, but they have been around for a long time, and they are definitely picking up more and more with the sophistication of the markets and the requirement of liquidity from certain managers and for private equity funds they are used as a liquidity tool. 

They can be used either to do some strategic follow-ons at the portfolio level, or just we saw some clients during COVID taking the opportunity in the market to make a new investment when it was allowed by the investors. So, they put NAV financing in place at the portfolio level to make new investment and take advantage of the markets while there were some interesting opportunities. So that's kind of the different cases where we see them being put in place and they are always, I would say, put in place for private equity fund managers while they are at a more mature stage, fully deployed in terms of capital, and only looking at the assets.

Speaker 1 (09:15): Emmanuelle Dotezac

Thank you so much, Sarah, for explaining the mechanics of fund financing. Gregory and Camille, from a borrower's perspective, can you explain what are the benefits and hurdles of using fund financing? Gregory, from the credit side?

Speaker 3 (09:32): Gregory Beauchamps

Yes, as a general partner, we definitely value operational efficiency. I think, as Sarah mentioned the subscription line brings a lot to the mix here for a private debt fund, drawing on an equity bridge facility, allows for a smoother loan settlement process we’ve seen, and then wait 10-12 business days for completion of the capital calls. These bridge loans are short-term, up to 364 days, which is plenty enough to allow for for fund deployment. And, we mentioned it, the acquisition of investors who joined at the end of the subscription period. The fund is definitely facilitated by an equity bridge line. 

On the other end, the asset-backed facility NAV financing actually helps reaching out to a different client base. As a general partner this is something that we definitely value obviously. Leverage when done right can enhance the limited partner IRR over the life of the fund, but not only it also helps boosting the quarterly cash yield of your investments. So, it's just very interesting for a strategy like private debt, where we actually distribute to our LPs on a quarterly basis, the cash income that we collect from the underlying debt instrument and the financing helps boosting this cash shield on a regular basis. I think we can say that the two work well together actually cause when you're launching a leveraged strategy or leverage sleeve, as Sarah mentioned, a subscription line definitely helps cause it delays the first LP capital calls at a time when you start deploying your fund and the portfolio diversification is lacking a little bit. And so the leverage is not fully effective yet.

Speaker 1 (11:33): Emmanuelle Dotezac

Thank you so much, Gregory. And Camille, from the private equity side?

Speaker 4 (11:40): Camille Defaye

Yes. Thank you, Emmanuelle. Yes, as Gregory and Sarah said, back in 2015, I think Latour Capital was one of the first French movers to set up a bridge solution. But now we see that everyone is using it. 

What I can add here is that in the COVID context, and after the shutdown phases, we see that the private equity landscape is highly competitive. So, if you want to win a deal and to be more appealing from manager, from seller, from everyone in a transaction, you need to be flexible, and as Gregory said, with the equity bridge solution, the thing is that you can call the money just with three days. So, it means that the final amount you have to call will be 3-4 days before the closing. So, you can offer to the seller, to the managers, some solution to bridge money, to bridge syndication, and to offer reinvestment solutions to everyone. It's really, really important, when you have like three or four weeks to actually make a deal. Of course, there are other pluses and, as Sarah said, equity bridge financing is the return booster. You will call the money one year after. So, what I can see that on average, it's a booster of three, four points on your IRR. And I can also say that there is no risk of nonpayment of an investor three, four, one day upfront of the closing, which is really, really helpful for us.

Speaker 1 (13:10): Emmanuelle Dotezac

Thank you so much, Camille. And how are your investors reacting?

Speaker 4 (13:15): Camille Defaye

I think they are very happy because the return booster is for everyone, us of course, but also for LPs. And we can see that this equity bridge solution offers a cash flow visibility for everyone, because you say, okay, I will call the money in, let's say 11 months, so they know the amounts, they know the dates. So it's really nice for everyone. And, also, it avoids call money calls for smaller amounts, like both fees, management fees, things like that. Actually, with the equity bridge, you will concentrate your capital call only for a major amount. And, I can tell you that LPs really likes this solution also for that.

Speaker 1 (13:57): Emmanuelle Dotezac

Thank you, Camille. And, David, as an investor, can you share your views?

Speaker 5 (14:03): David Checoury

Sure. I mean, if I put my head as an investor, I think that - first of all - it was very well explained by my main peers, in particular Sarah. I think that using the subscription line facility is indeed very useful for an investor/for an LP. As said, it gives, it gives a greater clarity on the timing of cash flows to have investors manage their own cash flows, but also it allows cash to be consolidated or batched to avoid any drawing downs on investors too often. So, this is indeed very useful. Now I would like to give another perspective, from an investor point of view, maybe another view as compared to, to my peers in here. We have been asked often by our investors: How is the leverage used by fund managers in the strategy we have committed to? 

For instance, we have established access vehicles for a fund of funds (in the) using LBO strategies, and it's very interesting to notice that the value creation to investors has varied across time. For instance, in the eighties the use of leverage represented about 50% of the value creation, whilst in the last decade it has dwindled, only representing 10%. Therefore, the investors nowadays want to often understand: What is the operational skill of the fund you commit to? What is in their value creation? Their investment talent? And for instance, we have acceptance on funds which have delivered some multiples, without a leverage, of four times. Therefore, one key question to put things into perspective for an investor is: What is the investment talent? 

Having said that, we are very excited about the development of all the topics we're discussing today. Indeed, these tools we are discussing today are innovative and bring big pluses which have been shared by my colleagues. So, in other words, an investor has in mind what is the investment talent, but also, and then secondly, to discuss about the leverage capabilities and indeed the two which we are discussing today are very useful.

Speaker 1 (16:41): Emmanuelle Dotezac

Thank you so much David. And Sarah, in light of what David just explained, when you are supporting a GP or fund which is looking for financing, what considerations should they have? How should a GP approach the market?

Speaker 2 (16:57): Sarah Lobbardi

So just to bounce back on what David said, which is very interesting, I think a few years ago there was a lot of noise in the markets coming from investors trying to understand more the use of leverage by fund managers. And there were a lot of articles in the press. The ILPA did a lot of work around this subject. And, I think it was a little bit kind of like an understanding from investors of how the facilities were used, how it was impacting the returns of the funds. And I think it was a more of an education and then getting more comfortable with the subject. And what has been interesting, actually, it has been quite a shift since then, because then what happened is that a lot of investors just said to the fund managers, we're comfortable with you using fund financing, but we would like in some cases to see the returns before the use of fund financing and after - it's okay to just see the effect and how much it's impacted the IRR. And that was fine. 

And now what we see is actually more investors challenging the fund manager saying, why are you not choosing fund financing? We see that other peers of yourselves that we are investing in on their funds, are using fund financing. And why are you not going to the wider market? So more and more we have fund managers coming to us saying, well, we were not planning to hire an advisor because we work with the same bank for maybe five years doing the same type of financing, but we have been challenged by our investors to do a wider research, to be more sophisticated about our financing strategy. 

So, I think that's a very interesting dynamic that we have seen evolving over the last few years. And I think a little bit what David said, for some investors, they like to have a more conservative approach, and they will only go to certain fund managers which are selling a purely unleveraged strategy but most of them we see are more and more kind of interested in the use of these tools. 

So that's just, I think an important point, I thought it was interesting to bounce back on. In terms of what we advise our clients when we work with them, I think it's a few things. The first thing is really to think carefully about the financing strategy. What we noticed is a few years ago, people were putting capital call facilities in place, and they will use the same kind of strategy go with the same type of lenders and replicate a little bit what they have been doing in the past. 

Now, the conversations we have with our clients are very different. It's kind of sitting down and thinking about- You are raising a fund, what kind of financing can you have? There are multiple different sorts of financing, and there are different ways to be kind of be sophisticated in terms of- Which facilities you use, when do you use them and how do you put them in place? So, we challenged quite a lot of our clients about thinking about - what's the purpose, what’s the real size of the needs, for how long do they need their financing? Can we put something else in place after a capital call facility, for example, to kind of again like improve that IRR and maybe like allow them to have some liquidity financing. So, it's really more of a strategic conversation that covers the whole life of the fund than just thinking I'm fundraising, and I need a capital call facility. 

So, I think, and we can see that clients are also thinking more like that. Now we have a few people who come to us and say, we have been doing this for the last decades. What are people doing? How can we do things better? And what can we do differently? And I think that's kind of part of the sophistication of the markets. 

Another thing that we always advise our clients, obviously pricing and cost is obviously an important feature. Not only are these financing are used to also boost the returns, but we don't want our clients to only be focused on this element. And not only when we come to NAV financing products like with debt, secondaries or private-equity funds, there is a lot more to it than just the costs. It's how do you build the right borrowing base for debt funds that is going to allow them to maximise the leverage but while they're having flexibility, being able to get easy access to the leverage for like, kind of an improved borrowing ways and not just having like fewer assets included in that borrowing base, how do you get like the flexibility over the next five years from your lender and not just from the inception? So, we're trying to sometimes have those conversation, that's flexibility, the right structuring. And, you know, like thinking about that long-term financing is as important as just going for the cheaper provider in the markets. 

And lastly, I think the only last thing I will cover obviously is we always advise our clients to think about the relationship with the lenders, being banks or non-banks, and make sure that they choose the right lenders. And again, we have seen a few lenders coming to the market, which are new entrants in the last few years but they may not be the most experienced for some asset classes or the most flexible. And there, again, we want to make sure that the clients, once the facilities are in place, have a good relationship with a lender and can be flexible and that they can kind of evolve that relationship on the long-term.

Speaker 1 (22:22): Emmanuelle Dotezac

Thank you so much, Sarah. Flexibility, right structuring and relationship with the lenders. Is it what you are seeing in the market Augustin, as a lender?

Speaker 6 (22:33): Augustin Duhamel

Yes, absolutely. First of all, I’d like to say that I concur with many things that Sarah is saying, and we have been doing NAV financing since 2008. So, to us, this is not something entirely new, but what we are seeing is clearly an acceleration in the market and the recent acceleration. To give you a sense, we've been operating for close to 15 years, but we have deployed 40% of our total investment in the last 12 months only. So, it's clearly a very strong acceleration. Now, maybe taking a step back and going into a bit more details on what is NAV financing and how it works, when GPs use it and what are the key reasons why they use it. Contrary to sub-lines, NAV financing is not using the uncalled capital of limited partners in the funds, it's only relying on the assets that are existing in the fund. It's only asset backed. As such repayment will come from the cashflows of the underlying portfolio companies, which means that you need to assess the cashflow profile of the funds, and you can only tailor the facility when you can assess those cash flows. 

When do GPS use those facilities? Typically, when they reach the end of their investment period, they have invested the fund, they have called money from their investors and as such the sub-line is fading, which doesn't mean that there are no reasons to continue using financing for the fund. And those reasons are typically two-fold and Sarah alluded to those. It's either to send money back to investors in the funds. And we see that typically for high performing funds, with strong early winners, and historically those funds were sometimes selling those assets early to manage the IRR of the funds.

Today, they don't have to sell them. They can make a fund recap or a subset of the portfolio recap so that those companies still generate early cash flows. But at the same time, the manager can keep them longer to grow them further. The other reason why GPs would take NAV financing, and again, Sarah mentioned that, and we see that more and more in the market, it's to invest more into the portfolio, either into existing portfolio companies, with follow-ons that are strategic, adding more value to the portfolio. And what we are seeing more and more as well is to make new investments in cases, for instance, when investment base is accelerating, the next fund is not necessarily ready yet, and there are opportunities to seize on the market, the GP would take a NAV financing facility at the fund level to make the last one or the last two investments, in the end, generate more performance for the fund. 

Which is, by the way, what should be the ultimate goal of those financing tools! Managers use them to optimise the performance of their firm and to optimise the cash flows for their investors. And that's what should be driving all that industry so to say the performance of the fund. And maybe to finish, going back to what Sarah and Gregory were saying, you have a number of players who are using NAV facilities more and more, some GPs are asking what the others are doing, some LPs are asking their GPs why they're not using NAV facilities. And what we see on our end is that the market is accelerating because there is more adoption and that adoption is coming from the top. That adoption is coming from the top managers, from the largest managers in the world, and they are really setting the trend for the for the others. And that's a very important feature in the market. They are showing the way to the to the others. 

And to conclude, lastly, going back again on some of the Sarah’s comments, what are those managers looking for when they are looking for the facility? Yes, price is important. Of course, it is important because in the end, that's what drives the performance. But beyond that - flexibility, capacity to adapt to the cashflow profile of the fund, and the underwriting capacity again, the relationship is important. When we as 17Capital underwrite a 500 million facility, it is important for the manager on the other side to know that they have a reliable partner who will be able to deliver on that 500 million. So maybe I'll pause there because I could keep on going for longer. Hopefully I have answered your query.

Speaker 1 (27:40): Emmanuelle Dotezac

Thank you so much, thank you, Augustin. So, we are seeing a definitive acceleration in the market. Gregory, we’d be interested to understand how do you see the future of the fund financing? Gregory…

Speaker 3 (27:55): Gregory Beauchamps

Yes, that's very interesting. David mentioned value creation and financing a leverage is not an objective in itself. It’s an essential tool to have in your toolbox. It allows you to address potentially different clients and deliver an enhanced performance when you have a performing strategy. But I agree with Augustin, flexibility is key. And as a structure, looking to the future, I would definitely see benefit in more flexible ways to finance or refinance our LPs, for example, providing shares of, and leverage credit funds as collateral. Definitely, this could enhance LP returns at a point in time when funds are, for example, already in their harvesting period. As for the asset back financing, on the more closer or short term future, I certainly think the lender market could benefit from enhanced local analyst coverage, a good understanding of local market dynamics to facilitate the discussions on the evolution of the value of your asset base. And Augustin mentioned it, this is your collateral, and you really, really want you to understand - all parties benefit from a stable and efficient leverage.

Speaker 1 (29:24): Emmanuelle Dotezac

Thank you, Gregory. And Camille?

Speaker 4 (29:28):  Camille Defaye

Thank you. Thank you, Augustin. Very interesting. And I really think that there are many pluses on the EBF solution, but, once it's set up, actually you still have the unknown on the investment pace and the investment phasing of your fund. And the EBF can be a very strong advantage, but the power of the EBF can also not be a hundred percent, if for example, you are doing many investments after three or four or five years of your fund lifetime. 

But really interesting here to see that NAV lending, for example, is actually specific on an operation - it's for a fund recap, or for example, at the end of the fund lifetime, a buildup financing or an investment financing. So, there is no unknown around NAV lending. Having said that, I clearly understand the opportunity of it, and I will follow the market on that because I see many, many opportunities. 

But we still need to be very clear and comfortable on the fact that there is risk of course, because, the collateral is the asset and the asset is already charged with an LBO debt, first, and secondly, on our bylaws, we still have some limits on the financing capabilities. We all know in France with our WAP Act, it was 10% now it’s 30% of the NAV. So, you know, there is a legal context also to take into account, but clearly, like Augustin said, I see many opportunities because when you are lacking of money, you don't have undrawn commitment in your fund, and you still want to do a major build up or to seize a major investment opportunity, it could be also be as a great solution. Clearly.

Speaker 1 (31:19): Emmanuelle Dotezac

Sarah, how do you see the future of financing as an advisor?

Speaker 2 (31:25): Sarah Lobbardi

Well, I mean, I think to add to what Augustin said, it has been a fantastic year. I think any lenders, any lawyers and ourselves, we had a lot of work - fundraising has been booming. So clearly it is a very positive future we're looking at. I think, I would just cover three main points that are very interesting. I think the first one is we will keep seeing the sophistication of the markets increasing. We'll move to a market where people are trying to optimise their financing strategy, being more thoughtful of which kind of financing they use and trying to be creative. We see more people using liquidity lights for open-ended funds, structured financing at the fund level, which is not really a capital call or NAV financing, but very bespoke and structured to their own financing needs.

So, I think that we kind of keep increasing and with that sophistication of the market, obviously I'm expecting that you will see more and more use of NAV financing across these different asset classes we've mentioned. And as an advisor, we see that already. We have a lot of managers which never used NAV financing before, who are reaching out to us and saying, we know they are being more used. We can see our peers and maybe like larger fund managers using them. We want to kind of pick up that trend and think of how can we put those kinds of financing in place. So I think when, before the market was maybe mostly dominated by capital call lines, in terms of kind of volume of transactions done, I think we're going to shift more and more towards a market where it's as equally used in the capital call facilities or the NAV financing.

And the last thing that is really interesting - coming to kind of this increased sophistication and different types of financing use - is the type of lenders within the markets. When I started in this market, it was mostly bank dominated. There were only very few players, like 17Capital, which were non-bank lenders. Today, we see a lot of non-bank lenders in this market. We see pension funds, insurance companies, which are providing capital call facilities, that either join syndication club deals, or are just providing it in bilateral kind of cases. We also see some fund managers or insurance companies coming to more niche size of the market providing for example, leverage to the GP, stakes in the funds. We also saw very recently someone who left the bank and launched the first non-bank lender of capital call facilities, which is backed by institutional money like pension funds.

So, I think this is really an interesting trend in the sense that we are seeing more and more of these non-bank lenders coming for different types of financing capital call and NAV financing, and also people like, 17Capital coming to private equity, but also now providing NAV financing to the funds. And I think that is going to be an increasing trend because there is a lot of liquidity in the market. And a lot of these players want to be able to have high returns and we’ll see, I don't know if it will evolve like the leveraged finance market where now a lot of the debt funds are providing these lines instead of the banks, but they think that's really the trend that I find really interesting.

Speaker 1 (34:51): Emmanuelle Dotezac

Thank you, Sarah. And Augustin, as a non-bank lender, can you share your views on the evolution of the lenders market?

Speaker 6 (35:01): Augustin Duhamel

Sure, first of all, I'll say that a lot of things that Sarah has just said, we see exactly the same trends from our perspective as a provider of financing, more flexibility from those providers, more sophistication from market players and in the end, more adoption. And while more adoption may be bouncing back on what David was saying, yes, leverage should be looked at carefully, especially at the portfolio company level, because that's when it's adding more pressure to those companies. But in the end, why are GPs using those facilities? Basically, to improve fund performance and to reduce the spread between gross and net. And that's really what will be driving more adoption and more volume in the end on the market. From our end, we estimate that the market opportunity for NAV financing is around a hundred billion dollars per year.

We are seeing $25 billion of deals through on our end. So, we are only, seeing a portion of that, but we think it's much larger than that. It will keep on growing. And we really think that we will see a similar trend as what we have seen on the direct lending market over the last decade. It has been booming and it's not now an asset class of its own. And we think that NAV lending will also become an asset class of its own. It will be the new direct lending in the next few years.

Speaker 1 (36:37): Emmanuelle Dotezac

Thank you so much Augustin for these concluding thoughts. I would like really to, on behalf of IQ-EQ, to thank all our panelists today, we learned a lot about the growing importance of fund finance. Please do not hesitate to share any question with us or continue the dialogue. Thank you so much. And looking forward to seeing you soon.

 

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