Whilst lenders may have tightened up on their lending, there still appears to be appetite amongst lenders to provide funding to funds. In particular we have seen a number of transactions involving private equity funds and the provision of equity bridge facilities (also known as capital call facilities).
Private equity funds, unlike other types of funds, do not require investors to invest their monies at the launch of a fund. The funds are often structured as Guernsey limited partnerships and the investors make a capital commitment to invest a certain sum of money into the private equity fund over its investment period. Once the private equity fund has sufficient capital commitments, it will hold a series of closings, where, once it has identified suitable investments, it will draw down on the capital commitments of the investors in trances and the investors will be bound by the provisions of the limited partnership agreement to invest that money as they have committed to the fund. Once it receives the cash the fund can invest in the identified assets.
From time to time, private equity funds can find themselves in a situation where they need to make the underlying investment before the time they can draw down the capital commitments. Alternatively, it may be that they have to pay a deposit to secure the investment, in these circumstances an equity bridge facility provides a short term form of finance to solve this issue, until the capital commitments are received. Generally, the bridge facility is repaid when the limited partners made their required commitments.
Considerations for Lenders
From the lender's perspective there are a number of issues to consider when providing such a facility. It will want to carry out due diligence focusing in particular on the limited partnership agreement, any side letters and subscription agreements and the identity and financial standing of the limited partners.
It is important to check that the general partner of the limited partnership has the power and capacity to enter into the facility and to grant security over and assign its rights under the limited partnership agreement. We would expect to see express provisions in the limited partnership agreement providing power to borrow money and grant security. There are, however, sometimes limits to the amount that can be borrowed.
Usually, the core security that the lender will take will be the general partners' rights against the limited partners under the limited partnership agreement and therefore it is important to also look at the other powers that the general partner has. Generally the lender will want the general partner to have the power to:
- make calls on undrawn commitments (i.e. be able to require the limited partners to make their capital commitments);
- issue and deliver drawdown notices to limited partners; and
- require non-defaulting limited partners to make up any short fall which arises should other limited partners fail to fund their LP commitments.
Where the limited partnership agreement is governed by Guernsey law, taking security over the rights of the general partner to drawn down commitments from limited partners will be effected pursuant to the Security Interest (Guernsey) Law 1993 (the "Security Interest Law").
Security over the rights will be taken by assignment assuming that the rights are assignable under the limited partnership agreement pursuant to Section 1 (6) of the Security Interest Law, which provides that a security interest is created where the secured party has title to the collateral pursuant to a security agreement and where that title is acquired by assignment. There is a difficulty, however, as in order to create valid security under the Security Interest Law "express notice in writing" that the collateral has been assigned must be given to the limited partners.
This is often a sticking point for managers who would prefer not to give notice. This is sometimes because of the nature of investors in private equity funds who may want to become involved in negotiating the terms of the loan and security agreements. Managers will therefore often argue that notice should only be given on an event of default or if it must be given, that notice will be given when other communication is sent to the limited partners.
Both these scenarios pose a risk for the lending bank because, as explained above, security by assignment is not given under the Security Interest Law until the notice is given. Notification is not, as is the case in some other jurisdictions, just a perfection requirement.
If notification is not given until an event of default occurs or when other communication is sent to the limited partners, the lender will not be secured for this period. This is a risk based decision for the lender.
It is also important to check whether the limited partnership agreement to establish whether a new limited partner investing in the fund after the loan and security documentation has been point in place will be bound by the relevant arrangements. It is important to check the limited partnership agreement in this regard and it may be appropriate to include provisions in the security interest agreement requiring that future limited partners are given notice of the security created under the security interest agreement.
In conclusion, there continues be a growing market for the provision of financing to private equity funds but there are some practical issues which funders must consider when making such facilities available and taking security over partnership rights. Supplemental security over relevant bank accounts is also useful for lenders to have in place.
This article was originally published in Finance, Offshore – Winter 2012.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.