It’s no secret that fund managers are becoming increasingly resourceful in their effective use of leverage in the net asset value (“NAV”) space of the fund finance market (see FinancialTimes article). What we have seen since the onset of the pandemic is an increasing number of financing solutions suitable for family offices and ultra high net worth individuals (“UHNWIs”) looking to leverage their existing limited partnership interests in private funds (“LP interests”) .
Many of these transactions are provided (or initiated) bilaterally by the Private Client team of a financial institution familiar with fundraising products. However, we have seen a number of deals where the relevant relationship manager introduces their fund finance colleagues to the relevant team acting for the family office or UHNWI to help develop a fund finance solution to help free up of the value of the LP interests so that the family office or UHNWIs (as the case may be) have greater firepower in pursuing their investment strategies. In almost all cases, there is a strong relationship between the manager of the private wealth relationship and the UHNWI/family office (or their representatives).
Finance Fund Friday previously published articles on considerations in NAV transactions from a US perspective (here and here) and many of these considerations apply to NAV facilities for UHNWIs/family offices in the European market.
The usual structure for this type of financing follows the most common secondary agreements in that a 100% owned special purpose vehicle (“SPV”) (usually structured as a limited liability company or a limited partnership itself and established in a familiar offshore jurisdiction) owns the LP interests (and is the registered investor for the underlying fund). The SPV is then the borrower in the financing and security is given over the SPV (either as security for shares or, if the SPV is a limited partnership, security over the interests of the company in general partner in the SPV itself and security interests in its general partner) as well as security of bank accounts on the accounts into which distributions and other LP interest income are paid.
Since UHNWI/family office NAV funding is primarily a relationship product between the relevant financial institution and the UHNWI/family office NAV, the structures are more bespoke than the usual secondary NAV funding. For example:
- the purpose of the financing may include the upstream channeling of loan proceeds to assist investments of related entities;
- the owner of the interests (the “Master”) in the SPV is generally a guarantor;
- as the SPV is usually established for financing purposes and usually holds just enough LP interests to comply with the financial covenants, there are solvency covenants that burden the parent company;
- in some cases, UHNWI is required to provide a personal guarantee in favor of the lender (and they may also be subject to credit tests);
- since the UHNWI will have a deep and extensive business relationship with the lender, assets outside of LP interests frequently contribute to the calculation of financial commitments under the financing (such as stocks, securities, fixed income instruments and gold); and
- some financing has no fixed maturity date and is largely repayable through agreed cash transfers and on demand (with a relatively generous notice period).
As the main collateral supporting this type of financing is the value of the LP interests, as mentioned in the other Finance Fund Friday articles mentioned above, due diligence should be undertaken on investment documents relating to LP holdings to analyze potential risks/restrictions of taking security over the SPV (e.g. limited partnership agreement relating to an LP holding may contain restrictions around indirect security and/or changes in ultimate beneficial owners and therefore solutions to this must be put in place). In addition to this, ownership documents relating to LP Participations (such as subscription agreements and side letters) should be reviewed.
As many private fund GPs have extended the life of their funds during the pandemic when asset valuations have been negatively affected, the need for family office/UHNWI funding has increased significantly in order to fill a liquidity crunch to which face many investors. Recent developments in sanctions legislation and policy adopted globally are likely to affect a small number of these agreements being established. However, given the current economic climate (particularly with regard to inflation rates in Europe), coupled with European banks and UHNWIs/family offices seeking liquidity solutions as well as new entrants to the NAV secondary fund financing (which already has strong ties to UHNWI and family offices in other parts of this lender’s business), so we expect this area of fund financing to continue to grow significantly this year and next year.