Article

Management Fee Credit Facilities

By Kristin Rylko1

As the subscription credit facility market depository bank would be needed to perfect the matures,2 lenders seeking a competitive Lender’s security interest in the Collateral advantage are expanding their product offerings Account. Additionally, since the General Partner, to private equity funds (a “Fund”) from the Management Company or another Sponsor- traditional capital call facilities made to closed- affiliated entity (a “Special Limited Partner”) end Funds to other financing products, including generally has an equity investment in the Fund, lines of credit to open-ended Funds, separate- the security for a Facility may also include a account vehicles and net asset value facilities.3 pledge by such entity or other Sponsor-affiliated Another emerging product gaining traction in the investing entity’s right to receive distributions market with some Fund sponsors (a “Sponsor”) is from the Fund and, in some instances, its limited a so-called management fee credit facility (a partnership interest. “Facility”). A Facility is a loan made by a bank or other financial institution (a “Lender”) to the Background general partner (the “General Partner”) of the In a typical Fund structure, the General Partner Fund or a Sponsor-affiliated management or the Management Company receives company or investment advisor (collectively, the Management Fees as compensation for evaluating “Management Company”) of a Fund, and has a potential investment opportunities, providing collateral package that is distinct from other types investment advisory services and attending to the of security arrangements commonly associated day-to-day activities of managing the Fund.4 The with Fund Financings. Management Fee also covers operating expenses The basic collateral package for a Facility consists (such as overhead, travel and other general of the General Partner’s or Management administrative expenses) as well as salaries for Company’s, as applicable, right to receive the Management Company’s investment management fees (“Management Fees”) under professionals and other employees. The the Fund’s limited partnership agreement (the Management Fee payable by an Investor is often “Partnership Agreement”) or other applicable determined by multiplying a percentage5 times management or investment advisory agreement such Investor’s capital commitment. In addition, (the “Management Agreement”), and rights some Management Fee structures include a related thereto, together with a pledge over the component that is based on the Fund’s deposit account into which the Management Fees performance so as to provide additional incentive are paid (the “Collateral Account”). A control to the General Partner or the Management agreement among the General Partner or Company to maximize the Fund’s performance. Management Company, the Lender and the

Facilities are becoming increasingly popular for a receiving the Management Fees are important number of reasons. First, Sponsors may find a because the Lender is ultimately looking to the Facility attractive because it provides the Sponsor Management Fees as the source of repayment of (or applicable affiliated entity) with immediate the Facility in underwriting the risk associated capital to smooth its cash flow and pay operating with lending to a particular Sponsor. expenses in between the typically quarterly or Even though Management Fee performance semiannual payments of the Management Fees it history and management experience of a receives. Second, post-economic downturn, particular Sponsor may make it an ideal Investors are increasingly interested in seeing candidate for a Facility, as more fully described Sponsors make larger investments in the Funds below, not all Funds will have Partnership they manage to increase their “skin in the game” Agreements, Management Agreements or and further align the Sponsor’s and Investors’ Management Fee structures that are suitable for a interests in maximizing Fund performance. By Facility. Further, some Partnership Agreements leveraging the income stream from future limit the General Partner’s or Special Limited expected Management Fees, a Facility may help Partner’s right to pledge its equity interest in the enable a Sponsor or its Special Limited Partner to Fund, although, a pledge of any distributions make a larger commitment to a Fund than it associated with such equity interest may be otherwise may be able to commit. Also, to the possible. Thus, the Partnership Agreement extent a Sponsor or its Special Limited Partner is and/or Management Agreement must be an Investor in a Fund, a Facility may be drawn on carefully analyzed to confirm that the intended short notice to permit the Sponsor or Special collateral can be granted to the Lender and the Limited Partner to honor a capital call prior to Lender will be able to adequately enforce its receipt of cash from the principals or employees rights against the collateral. that ultimately constitute the Sponsor or Special Limited Partner. From the Lender’s perspective, Structure and Loan Documentation aside from earning revenue from the fees and interest income generated by a Facility, providing Facilities are typically structured as revolving a Facility to a Fund is also a chance for the Lender lines of credit to the General Partner or to broaden its relationship with the Sponsor and Management Company (depending on the Fund’s develop a deeper understanding of the Sponsor’s structure), secured by a pledge by the General business and its potential financing needs. This in Partner or the Management Company of its right turn may lead to opportunities for a Facility to receive the Management Fees and the account Lender to provide other products such as into which such Management Fees are paid. If the subscription credit facilities, net asset value Sponsor group has made an investment in the facilities, portfolio-company level financings or Fund through a Special Limited Partner or other perhaps even private wealth products to the affiliated entity, the collateral package may also Sponsor’s principals. include a pledge of the right to receive distributions from the Fund and the account into While there are many potential benefits to both a which such distributions are paid. If the Sponsor Sponsor and a Lender associated with a Facility, manages more than one Fund, the collateral it is important to note that a Facility is best-suited package may include Management Fee streams for established Sponsors that have significant from multiple Funds and the right to Fund management experience and a proven track distributions from those Funds. record of receipt of the Management Fees, ideally from a diverse platform of Funds. Management The basic loan closing documentation for a experience and an uninterrupted history of Facility will typically consist of (i) a credit agreement, (ii) a security agreement pursuant to

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which the General Partner or the Management that are tailored to address the unique features of Company assigns its rights under the Partnership a Facility’s collateral package. Such provisions Agreement or the Management Agreement, as may include a requirement that the General applicable, to receive and enforce the payment of Partner or the Management Company receive a Management Fees and proceeds thereof, (iii) a minimum amount of Management Fee income, or pledge of the Collateral Account into which that the amount of Management Fees received Management Fees are to be paid, (iv) a control does not fall below a certain specified percentage agreement covering the Collateral Account to of the aggregate commitments of the Fund’s perfect the Lender’s security interest therein and Investors. A Facility will normally include permit the blocking of such account by the limitations on amending the Partnership Lender, (v) a security agreement from the Special Agreement or the Management Agreement, and Limited Partner or other Sponsor-affiliated entity prohibitions on terminating or waiving the pledging its right to receive distributions from the General Partner or the Management Company’s Fund, if it is the part of the collateral package, right to receive payment of Management Fees. together with a pledge of the deposit account into Additionally, so that the Lender can monitor the which such distributions are to be paid and a Fund’s overall performance (and have advance control agreement covering such account, warning of potential performance issues that may (vi) Uniform Commercial Code financing give rise to a reduction in Management Fees or statement(s) filed against the applicable pledging Investors balking at paying Management Fees), a entities, and (vii) and customary opinion letters, Facility will usually require regular financial certified constituent documentation of the Fund reporting and may also include a minimum net and pledging entities, evidence of authority and asset value test with respect to the Fund’s related diligence items. investments or a similar financial covenant with respect to the General Partner, Management In addition to the traditional collateral package, it Company or Special Limited Partner, as is not uncommon for a Lender to receive a applicable, and its investment in the Fund. Some personal guarantee by one or more of the Facilities that include a pledge of distribution principals in the General Partner, the rights may contain a maximum loan-to-value or Management Company or Sponsor to support the similar metric measured by looking at the Special Facility. The extent of such a guaranty is often Limited Partner’s pro rata share of the underlying negotiated, and it is not unusual for a principal’s portfolio investments in the Fund. guaranty to be limited to a capped amount based on its pro rata ownership percentage of the Partnership Agreement & Management underlying Fund and the related outstanding Agreement Diligence balance of the Facility, as opposed to a more traditional unlimited (or joint and several) As part of due diligence for any Facility, a Lender guaranty of the Facility. A guaranty may also be must carefully review the Partnership Agreement delivered by the Special Limited Partner, the and Management Agreement for any restrictions General Partner or the Sponsor, depending on the on the right of the General Partner or the structure of the Facility and the identity of the Management Company to pledge its right to borrower under the Facility. receive Management Fees or the Special Limited Partner’s ability to pledge its right to The terms of a Facility will typically include distributions. For example, a potentially customary representations, warranties, problematic, though not uncommon, restriction affirmative and negative covenants and events of is that the General Partner or Special Limited default that a Lender would expect to see in any Partner cannot pledge its economic interest in the secured financing, along with a few provisions

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Fund, which would include its equity interest, Agreement and the Management Agreement will without the consent of a certain percentage of the dictate whether a Facility is permissible and how other Investors in the Fund. Some Partnership and when Management Fees are to be paid, Agreements allow for such pledges without the exogenous events may occur that could affect the consent of the other Investors while others do payment of Management Fees. For example, in not. To the extent Investor consent is required, it the late 2000s during the market downturn, may be an impediment to entering into a Facility. Sponsors with troubled Funds in fact suspended or eliminated their Management Fees. Even In addition, the Partnership Agreement or the though such activities would be prohibited by the Management Agreement should be reviewed to loan documentation for a typical Facility, it is determine how Management Fees are paid, and important for Lenders to consider the overall whether they may vary over time. For example, investment and economic environment in which a the Management Fee may decrease upon Fund operates, as market conditions may stress termination of the period in which the Fund is the underlying underwriting assumptions of a permitted to make new investments. It is Facility. important for the Lender to understand whether Management Fees are paid by the Investors Conclusion directly to the General Partner or the Management Company, or if Management Fees While Management Fee Facilities have not been flow through the Fund and/or the General very common to date, they are becoming Partner (or another affiliated entity) to the increasingly popular and offer an opportunity for Management Company, as applicable, so that the a Lender to kick off or expand its relationship relevant Fund-related entities are included within with a Fund Sponsor. With a careful review of the the scope of the collateral documents to minimize relevant operating and constituent documentation potential leakage, if necessary. of a Fund, it may be possible to structure a Management Fee Facility to offer a seasoned Some Partnership Agreements provide for Fund Sponsor increased liquidity while satisfying Management Fee offsets, whereby receipt by the a Lender’s underwriting criteria. Please don’t Sponsor, its principals, employees or other hesitate to contact any of the authors with affiliates of advisory, break-up or other similar questions regarding these Facilities, including the fees and income related to the investment various structures that can be implemented in activities of the Fund may reduce the amount of connection with their establishment. the Management Fee. The Partnership Agreement and the Management Agreement should be reviewed to determine if such offsets exist, and Endnotes the Lender should consider whether the loan 1 Kristin Rylko is a partner in Mayer Brown’s Banking & documentation should prohibit the General Finance practice. Partner or the Management Company from 2 A subscription credit facility, also known as a capital call applying any discretionary offsets if possible. facility, is a loan made by a bank or other credit institution Alternatively, the Lender may consider to a private equity fund, for which the collateral package is requesting that any such advisory fees or other the unfunded commitments of the limited partners in the fund (the “Investors”) to make capital contributions when income or proceeds that may be offset against called by the fund’s general partner (as opposed to the Management Fees be included as part of the underlying investment assets of the fund). For a more collateral package in addition to Management detailed description of the subscription credit facility Fees if the Fund’s documents permit it. market and features of the subscription credit facility product in general, please see Mayer Brown’s Fund Finance In underwriting a Facility, Lenders will want to keep in mind that while the Partnership

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Markets Legal Update “Summer 2013 Subscription Credit Facility Market Review.” 3 For an in-depth analysis of certain alternative Fund financing products, please see Mayer Brown’s Fund Finance Market Legal Updates “Structuring a Subscription Credit Facility for Open-Ended Funds,” “Separate Accounts vs. Commingled Funds: Similarities and Differences in the Context of Credit Facilities” and “Net Asset Value Credit Facilities.” 4 Depending on the Fund’s structure, Management Fees may be paid by the Investors through the Fund or GP to the Management Company or directly to the Management Company. 5 Historically, the percentage has usually ranged from 1.5% to 2% per annum.

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