The use of subscription lines to cover capital calls has evolved from short term bridge facilities (generally paid off within 90 days) into longer term facilities used by fund managers for cash management and greater flexibility in completing transactions, through the avoidance of the immediate need to call for capital from the fund’s limited investors.  This expended use of subscription lines, however, has raised certain issues for limited partners in connection with and the alignment of their economic interests in subscription line use with the interests of the general partner.  The Institutional Limited Partners Association (ILPA) recently published new guidance in this area:  Subscription Lines of Credit and Alignment of Interests: Considerations and Best Practices for Limited and General Partners (June 2017).

Major areas of the ILPA’s concern with the use of subscription lines include:

  • Performance Comparability; Claw back Issues. The ability to delay the actual call for capital compresses the J-curve changing the calculation of the internal rate of return (IRR) and related preferred return thresholds.  This makes it more difficult to compare fund performance across funds.  Also, if the calculations are made from the time of the actual capital call rather than the time a draw is made on the line of credit, the IRR may be greater and preferred return hurdles may be achieved earlier.  The early achievement of such hurdles may also lead to claw back issues if the general partner receives amounts which ultimately need to be returned due to poorer fund performance later on.
  • Expenses. A subscription line creates direct upfront expenses for the partnership.  Poor performing funds may not be able to recoup some of those expenses.
  • Liquidity. An event of default on a subscription line related to a manager, or an event affecting the market generally, can result in there being multiple simultaneous capital calls, which may strain some limited partner resources.  The expanded use of subscription lines can mask, to some extent, the aggregate exposure of some limited partners.
  • Ceding Control to Lenders.  The terms of the subscription lines may cede control to lenders under certain circumstances on various fund decisions and assignments.  Limited partners may have entered these investments based on their view of the manager, but now some of the manager’s discretion may have shifted to the lenders.
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