Equity bridge financings: an overview

March 2015 | EXPERT BRIEFING | BANKING & FINANCE

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Equity bridge facilities (EBF), also known as ‘subscription line facilities’ or ‘capital call facilities’, are short-term loans, leveraged on the limited partners’ commitments of infrastructure, private equity, real estate or other funds, and usually take the form of revolving facilities. The facility is granted at the fund’s level (subject to applicable legal and regulatory limitations) or through a special purpose finance vehicle held by the fund with an accompanying guarantee from the fund. In this short note, we summarise a number of key features of EBFs.

Why are EBFs attractive to fund managers?

An important impact of an EBF is that it allows capital calls to be delayed, thereby providing greater flexibility to the fund’s management company to control profitability. The EBF is used by the fund to finance projects, or if necessary to pay any costs incurred upon a failed acquisition (e.g., advisory fees). The delay to call capital from investors improves the IRR at exit due to the costs of the EBF being less than the rate anticipated by investors. For example, an EBF of one year may reduce the amount of time between capital calls and the sale of an asset from five years to four years, thereby reducing the time denomination employed in calculating and improving the IRR.

Furthermore, the due diligence conducted by lenders is generally limited to the powers of the manager or general partner under the fund’s documents, any side letters agreed with investors, and subscription agreements. The core of the due diligence is conducted on the commitment period, any limits applied to borrowings and the security and, if applicable, the guarantee that may be granted by the fund, the rights of the limited partners to transfer their commitments to third parties and excuse rights, as the main security is the right of the lender to call undrawn commitments under the fund’s documents as well as any (future or present) claims, receivables, rights or benefits of the fund, acting through its manager or general partner arising out of or in connection with the fund’s documents. Such security varies from one jurisdiction to the other. For instance, a power of attorney is granted by the general partner to the lender for English borrowers. For Luxembourg borrowers, an assignment by way of security is granted by the manager or general partner and the fund to the lender, together with a pledge over the bank account of the fund and an assignment of all undrawn commitments of its investors with an express right for the lender to request direct payment of any sum due under the EBF from the investors of a French fund.

EBFs size and economic terms

In practice, there is a significant variation in loan size, ranging from €50m to €500m-plus. Lenders generally compute the maximum potential borrowing amount as a percentage of the commitments of ‘qualifying investors’ (e.g., 80 percent of AAA-rated investors’ commitments) subject to a ‘haircut’ (e.g., 20 percent typically applied to those investors with a participation greater than 20 percent of total commitments). The cases where an investor may be excused or transfer its commitment are therefore crucial to the lender. Qualifying investors include financial institutions, public or private pension plans, investors with assets valued greater than an amount determined by the lender, investors meeting rating agency requirements (as set out in the facility agreement) and such other investors as the lender may determine in its discretion given that, from the lender’s perspective, the quality of the investor base should remain unchanged for the duration of the EBF. The costs of borrowing depend on the funds size, investors’ risk and the main trends recorded in the last quarter of 2014, which showed a margin between 1.85 to 2.25 percent for EBFs granted for a period between 1-3 years, a commitment fee ranging between 0.25 and 0.50 percent, and an arrangement fee between 0.25 and 0.75 percent.

In addition: (i) capital calls are usually sent to investors 10 to 20 days prior to the repayment date of the facility; (ii) the margin is made by reference to the interest period, i.e., it may be one, two or three months’ interest, or any other such period as agreed with the lender. The margin is payable at the end of the interest period, or in the alternative, is capitalised; (iii) borrowers generally prefer an uncommitted facility rather than a committed facility to limit borrowing costs; and (iv) financial covenants are frequently set with a debt to qualifying investor undrawn commitment ratio of 1:1.1 / 1.5, and a debt to aggregated NAV and qualifying investor undrawn commitment ratio of 1:2.0 / 2.5, with the facility to be covered at all times by 1.5x the unfunded commitments of the fund’s investors.

Specific representations and undertakings

Borrowers or guarantors will represent that the ‘excused’ undrawn commitments of the investors do not exceed the total undrawn commitments of investors, and that there are no other creditors of the fund or borrower SPV other than the manager. Other specific covenants include: (i) the manager or fund’s obligation to call a minimum amount from the fund’s investors on an agreed frequency; (ii) the manager or fund’s obligation to provide information on the investors’ commitments (e.g., failure to pay, exclusion events, key man events, excused investors); (iii) subject to the security package, the manager or fund’s obligation to provide all information necessary to allow the lender to issue drawdown notices (e.g., amount of undrawn commitments by the investor, contact details, copies of applications); (iv) no distribution by the fund while amounts are outstanding under the facility or if an event of default has occurred; (v) no borrowing during a key man event and where a change of control of the manager has occurred; (vi) a negative pledge over the undrawn commitments of the investors; (vii) an obligation to pay the undrawn commitments on a pledged bank account; and (viii) an obligation to pursue defaulting investors and to request payment of the shortfall to the other non-defaulting investors.

Specific events of default

As with the representations and warranties, events of default will depend on the type of fund, but generally include: (i) the removal of the manager upon its insolvency; (ii) the termination of the fund; (iii) a cancellation threshold (usually 5-20 percent of undrawn commitments being cancelled); (iv) an insolvency threshold (usually 5-20 percent of investors becoming insolvent); (v) a defaulting investor threshold (where investors fail to comply with their obligations to fund their undrawn commitments); (vi) a transfer threshold (where an investor’s undrawn commitments are transferred to a third party after the execution of the facility agreement); and (vii) an excused investor threshold (where investors are excused from complying with a drawdown notice).

Conclusion

A detailed analysis of the investment structure and the investor is always critical in determining the key terms of the EBF to be granted to a fund, especially in light of the potential impact on the third-party lender’s capital costs (e.g., separation of risks and recovery, resolution planning for credit institutions, etc.) In addition, regulatory due diligence into the fund and its investors is necessary to assess whether an EBF is preferable to investment finance, to define the duration of the financing, and to generally review the impact of the financing on the fund’s investors (e.g., the impact of Solvency II on the fund’s financing and current insurance regulations).

Alexandrine Armstrong-Cerfontaine is the managing partner of the Luxembourg office at King & Wood Mallesons LLP. She can be contacted on +352 27 47 56 3401 or by email: alexandrine.armstrong-cerfontaine@eu.kwm.com.

Alexandrine Armstrong-Cerfontaine

King & Wood Mallesons LLP