Article Benefits of Fund-Level Debt in Acquisition Finance Frederick C. Fisher IV, Christopher M. Chubb and Anastasia N. Kaup 1 Introduction untested $50 million Fund I), the assets of the fund are typically the primary basis for a Private equity and other investment funds lender's underwriting and, in the case of a have traditionally utilized portfolio company- secured facility, the sole collateral. In a secured level financing to finance acquisitions. These NAV facility, the lender can obtain liens on, types of financings have focused on the among other things, (a) the equity interests in portfolio company for both the debt portfolio companies (or holding companies underwriting and collateral package. The that ultimately own the portfolio companies), categories of these loans include asset-based (b) distributions and liquidation proceeds from loans (“ABL”), cash flow financings and real the portfolio companies or other investments, property mortgages, among other traditional (c) in the case of debt funds, loans extended lending products. by the debt fund to its borrowers and (d) fund- In our practice, we are seeing increased and level collection accounts. In other cases, opportunistic use of fund-level debt as an borrowers with creditworthy assets are able to alternative or complement to secured access credit based on borrowing base financing at the portfolio company level. Fund- formulas but without granting liens on their level debt can include net asset value (“NAV”) assets. credit facilities, subscription credit facilities and Loan availability under an NAV credit facility is facilities combining characteristics of both typically limited to a sum equal to (a) an NAV and subscription credit facilities (“hybrid agreed advance rate for a given category of facilities”). This article focuses on the relative assets (potentially subject to concentration benefits of using fund-level credit facilities to limitations for each category) multiplied by (b) finance acquisitions of portfolio companies the NAV of certain agreed “Eligible and/or assets thereof as compared to Investments.” NAV credit facilities are often traditional acquisition finance. subject to unique covenants and other terms Overview of NAV, Subscription and in financing agreements (e.g., the requirement Hybrid Credit Facilities to maintain a minimum NAV or loan-to-value ratio, or rights with respect to asset NAV credit facilities are fund-level facilities replacement). that look to investments of the fund as the Whereas NAV credit facilities look downward primary source of repayment. Although a to the underlying portfolio investments or lender may consider the strength of a fund in other assets of the fund and their value as its underwriting process (e.g., compare the collateral and/or source for repayment, credit evaluation for providing financing to a subscription credit facilities look upward to the successful $1 billion Fund VI versus an unfunded capital commitments of the Relative Benefits of Fund-Level investors in the fund. Financing Subscription (also known as “capital call” or Funds and lenders alike can enjoy benefits of “capital commitment”) credit facilities are now fund-level financing, particularly to facilitate well known and utilized by private equity acquisitions, including: funds of all stripes. For years, such credit • Decreased transaction costs due to having facilities have offered funds with numerous only one credit facility per fund (rather than benefits including: (a) quick access to capital to multiple asset-level or portfolio company- bridge timing gaps in and “smooth out” the level credit facilities), resulting in lower timing and receipt of capital calls from overall costs and low to no commitment or investors; (b) flexibility and nimbleness to broken deal costs. rapidly access and deploy capital to take advantage of time-sensitive and opportunistic • Timing benefits due to not having to investments; (c) the means to borrow smaller arrange, structure, coordinate and close amounts as needed and later call capital in multiple asset-level or portfolio company- larger amounts to reduce administrative level credit facilities contemporaneously burdens, maximize efficiency and bolster with, or in order to, facilitate acquisitions. positive investor relations; (d) access to letters • The ability to focus fund financial and of credit and the ability to borrow in multiple personnel resources on acquisitions, without currencies; (e) the ability to secure hedges, the need to run a simultaneous process to swaps and other derivatives transactions and secure asset-level or portfolio company- (f) the means to bridge capital needs in level financing. connection with an asset-level financing.2 • Lower relative cost of debt and increased Hybrid credit facilities are a blend of NAV fund profitability, for reasons including (a) credit facilities and subscription credit facilities. lenders’ greater comfort in the fund’s overall Collateral for hybrid credit facilities is performance, as opposed to performance negotiated on a deal-by-deal basis, but it can on an asset-level or portfolio company-level provide lenders with recourse to the basis; (b) multiple income streams from underlying investment assets that typically multiple portfolio companies and assets to support an NAV credit facility, as well as the support repayment; (c) reputational risk of uncalled capital commitments of investors that non-repayment; (d) decreased diligence typically support a subscription credit facility.3 costs and (e) better pricing on fund-level For hybrid credit facilities with a blended debt secured across a diversified pool of borrowing base, the proportion of the collateral, compared to stand-alone borrowing base made up of capital portfolio company-level debt. commitments versus NAV assets often • Multiple high-quality sources of repayment changes over time; as capital commitments are supporting a single-credit facility. called and those funds are deployed to make • Potentially increased deal flow for lenders investments, the value of those investments who are positioned to provide financing for builds up the borrowing base through the the fund through its investment cycle across NAV asset prong. The blended borrowing base various platforms. of the hybrid credit facility helps fulfill the • A single, top-level credit facility lends to financing needs of the fund at multiple stages high levels of cooperation between funds in its life cycle and obviates the need to and their lenders, increasing transparency refinance as capital commitments are called. 2 Mayer Brown | Benefits of Fund-Level Debt in Acquisition Finance into a fund’s ultimate business goals and financing processes, or with other creative strategy and promoting partnerships. approaches (e.g., placing what would • Lenders at the fund-level facility have a otherwise be mezzanine or junior-level debt in larger hold percentage of the fund’s overall a senior position at the portfolio company debt, with greater diversity of assets. level, which may be obtained at a much lower all-in rate than usual given its then senior • Potential pricing breaks and beneficial position in the capital structure). borrowing base adjustments depending on the assets and concentrations thereof Depending on the type, goals and comprising the borrowing base. characteristics of the fund, it is possible to Though beyond the scope of this article, we employ each of the aforementioned types of recognize that fund-level financing is not an financing and to call on uncalled capital ideal fit for every fund and situation. Potential commitments, as well as underlying assets and challenges to be addressed include: (a) investments, to fulfill varying capital and accounting and tax issues, e.g., how to allocate liquidity needs throughout the entire life cycle expenses at the asset or portfolio company of a fund. level or otherwise as desired, and international tax Market Trajectory and Conclusion implications for funds that have diverse Given the relative benefits of fund-level credit investments in multiple jurisdictions; (b) the facilities over traditional asset-level and risk of insolvency at the portfolio company portfolio company-level financing, as well as level (although this risk is likely limited for the overlap in collateral and sources of well-diversified and properly structured repayment, we see funds enjoying numerous funds)4 and (c) unique portfolio goals and benefits in obtaining fund-level facilities on a challenges, e.g., whether advance rates and stand-alone basis, and/or as a jumping-off eligibility criteria offered by lenders will permit point to financing at multiple levels of the funds to achieve preferred leverage levels and capital structure over the life of the fund. As a returns. fund’s capital demands, needs and goals evolve, fund-level facilities can provide unique We have addressed these issues in a variety of advantages in terms of flexibility. As funds ways for a diverse array of funds and can continue to mature and lenders shift their suggest solutions based on individual fund underwriting focus from individual characteristics and transaction dynamics. In investments to the strengths of funds many cases, these concerns can be mitigated themselves, we expect funds will utilize (and or resolved by consulting experienced counsel lenders will offer) additional fund-level early on in the fund formation and/or facilities and financing options. Endnotes 1 Frederick C. Fisher is a partner in Mayer Brown's Chicago firms,