Fund Finance in a Changing Economy

Fund finance has evolved significantly in recent years, adapting to the changing economic landscape. The growing demand for alternative investments has led to an increase in fund finance transactions, with 75% of respondents in a recent survey indicating an increase in such deals.

Investors are seeking more flexibility and customization in their investments, driving the development of new fund finance structures. This shift is evident in the rise of subscription credit facilities, which have become a popular choice among investors.

The economic downturn has also led to a greater emphasis on risk management, with fund managers prioritizing transparency and disclosure in their fund finance arrangements. As a result, 80% of respondents reported an increase in the use of collateralized loan obligations (CLOs) in their fund finance deals.

Fund finance transactions involve a wide range of structures, including subscription/capital call facilities, NAV facilities, and hybrid facilities.

These structures allow lenders to provide financing to borrowers, such as hedge funds and private equity funds, to meet their capital requirements. Our attorneys have represented clients on both lender and borrower sides of these transactions.

We understand the commercial perspectives and business goals of the various transaction structures, providing sound legal advice and practical commercial application of such advice in each relevant context.

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Our Fund Finance group consists of attorneys with finance, transactional, real estate, and applicable regulatory and tax experience. They're well-suited to guide clients through all facets of fund finance transactions.

The attorneys represent clients on both lender and borrower sides of various transactions, including subscription/capital call facilities, NAV facilities, and private equity secondaries fund acquisition finance transactions. They also represent clients in loans to investment companies regulated under the Investment Company Act of 1940, and loans to insurance companies and captive insurance companies.

We understand the commercial perspectives and business goals of the various transaction structures, providing sound legal advice and practical commercial application of such advice in each relevant context. This expertise is valuable for clients navigating complex fund finance transactions.

The attorneys have represented a wide range of clients, including hedge funds, private equity funds, sponsors, banks, and other financial institutions. They've also worked with alternative lenders, investment companies, life insurance companies, family offices, and high net worth individuals.

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Here are some of the types of structured credit and equity transactions our attorneys are experienced in:

SBICs are privately owned and managed investment funds licensed and regulated by the SBA.

They use their own capital, plus funds borrowed with an SBA guarantee, to make equity and debt investments in qualifying small businesses.

SBICs are a great option for small businesses that need additional funding to grow or expand.

Learn more about SBICs to see if your business might qualify.

The Small Business Innovation Research (SBIR) program is a great way for small businesses to engage in federal research and development that has the potential for commercialization.

This program encourages small businesses to think outside the box and come up with innovative ideas that can benefit the government and the private sector. The SBIR program is a competitive awards-based program.

In other words, it's a challenge for small businesses to come up with the best ideas and compete for funding. The program is designed to help small businesses turn their research and development into successful products or services that can be sold in the market.

The SBIR program is a great opportunity for small businesses to gain access to federal funding and resources that can help them grow and succeed.

For another approach, see: Funding for Startup Business

FOFs offer several advantages, including additional diversification, access to premium investment opportunities, professional management, and a simplified investment process. This can be especially appealing to individual investors who may not have the expertise or resources to create their own diversified portfolio.

One of the key benefits of FOFs is their ability to provide access to exclusive investment opportunities that individual investors might not otherwise reach. By pooling capital, these funds can invest in high-performing mutual, hedge, or private equity funds.

However, FOFs also have some significant drawbacks. One of the main disadvantages is their higher expense ratios, which can significantly eat into overall returns. This is because investors pay fees not only for FOF management but also for underlying funds.

Another potential issue with FOFs is the risk of diluted returns. By spreading investments across many funds, the performance of high-performing assets may be offset by lower-performing ones. This can result in more stable, potentially lower, overall returns.

Understanding and evaluating FOFs can be complex due to their multilayered nature. Investors need to understand not just the strategy of the FOF but also the underlying funds' strategies and performance.

Here are some of the key advantages and disadvantages of FOFs:

Fund finance offers several benefits to lenders, including relatively low risk, diversification of the lending portfolio, and cross-selling opportunities. It's a win-win situation for both lenders and borrowers.

One of the main advantages of fund finance is that lenders view these loans as being well-collateralized, carrying lighter capital reserve requirements. This makes them an attractive alternative to riskier forms of lending with similar yields.

A diverse lending portfolio is essential for any financial institution, and fund finance provides another tool with a unique risk profile to achieve this. By offering fund financing, lenders can attract a sophisticated and sometimes new client base.

The regulatory oversight for fund financing is often less burdensome, given its initial use case as a sidestepped option following the Global Financial Crisis. This is a significant advantage for lenders who want to minimize their regulatory burden.

Here are some of the key benefits of fund finance:

Fund finance options can be complex, but they're also incredibly versatile. There are several types to choose from, each with its own unique benefits and drawbacks.

Subscription lines, for instance, are a type of fund finance facility that allows general partners (GPs) to borrow against capital commitments from limited partners (LPs). They're typically considered low-risk, but lenders still need to be wary of the creditworthiness of LPs.

Leverage lines, on the other hand, use a borrowing base calculation to determine availability based on the value of the fund's underlying holdings, which serve as collateral. This type of facility is often used to increase dry powder above the equity invested in the fund.

NAV-based lines, another subset of Asset-Based lines, are secured by the underlying cash flows and distributions that flow up to the fund from its underlying portfolio investments. They're most common in the secondaries market, where collateral will take the form of LP interests that the secondaries fund holds in different vehicles.

Hybrid facilities combine elements of both subscription and NAV lines into a single, comprehensive facility, although usually at a slightly higher cost given the added complexity.

Here's a quick rundown of the main types of fund finance facilities:

Leverage lines are a type of Asset-Based facility that use a borrowing base calculation to determine availability based on the value of the fund's underlying holdings.

Importantly, these facilities are typically secured by the full holdings of the fund rather than a single asset, lowering the risk profile of the loan. This is a key benefit for GPs looking to increase their dry powder without taking on excessive risk.

Subscription lines are lines of credit or loans secured against the future capital commitment of LPs to GPs. They enable GPs to execute on fund investments on their own timetable and increase returns during the pre-funding period.

Typically considered low risk, lenders still need to be wary of the creditworthiness of LPs when extending subscription lines to a GP.

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Hybrid facilities combine elements of both subscription and NAV lines into a single facility, often at a slightly higher cost due to added complexity.

Multi-strategy funds have a single manager who oversees multiple investment strategies, often with a team of specialists in each area. This can provide a diversified portfolio with potentially lower fees and quicker adaptation to changing market conditions.

FOFs, on the other hand, may appeal more to investors who value diversified exposure with multiple managers and are comfortable with potentially higher fees.

NAV-based lines are secured by the underlying cash flows and distributions that flow up to the fund from its underlying portfolio investments. They are most common in the secondaries market and the private equity world.

Common fund finance facilities include subscription lines and asset-based lines, both of which utilize a borrowing base mechanism to determine availability.

Venture capital is a type of financing that can give your business the funding it needs to get off the ground.

Investors can give you funding in exchange for an ownership share and an active role in the company. This is different from traditional financing, which focuses on low-growth companies and provides loans rather than equity investments.

Venture capital typically focuses on high-growth companies and takes higher risks in exchange for potential higher returns. It also has a longer investment horizon than traditional financing.

To get venture capital, you'll need to go through a process that involves finding an investor, sharing your business plan, and agreeing on terms. The investor will review your business plan to make sure it meets their investing criteria, which often includes industry, geographic area, or stage of business development.

The due diligence review is a crucial step in the process, where the investors will look at your company's management team, market, products and services, corporate governance documents, and financial statements.

If the investor decides to invest, you'll need to agree on a term sheet that describes the terms and conditions for the fund to make an investment. Once you agree on a term sheet, you can get the investment, but be prepared to give up some portion of both control and ownership of your company.

A fresh viewpoint: Venture Financing

Venture funds normally come in "rounds", with further rounds of financing available as the company meets milestones. The company will need to adjust the price accordingly as it executes its plan.

Here are the key differences between venture capital and traditional financing:

If you want to retain complete control of your business, a small business loan is a viable option. To increase your chances of securing a loan, you should have a business plan, expense sheet, and financial projections for the next five years.

Having these tools will give you an idea of how much you'll need to ask for, and will help the bank know they're making a smart choice by giving you a loan. This preparation is crucial to getting approved.

You'll want to contact banks and credit unions to request a loan, and compare offers to get the best possible terms for your loan. This will save you money and time in the long run.

Intriguing read: Business Finance

If you're a small business owner looking to secure investment, the SBA has a few programs that can help. The Small Business Investment Company (SBIC) is a privately owned and managed investment fund that uses its own capital and SBA-guaranteed funds to make investments in qualifying small businesses.

SBICs are licensed and regulated by the SBA, and they can provide a significant amount of capital to growing businesses. They typically invest in businesses that have a strong potential for growth and profitability.

The Small Business Innovation Research (SBIR) program is another option for small businesses that want to engage in federal research and development. This program offers competitive awards to businesses that have a innovative idea with commercial potential.

To be eligible for the SBIR program, your business must be small and have a strong potential for growth. The program can provide up to $1 million in funding to support research and development projects.

If you're having trouble getting a traditional business loan, the SBA-guaranteed loan program may be a good option. This program allows the SBA to guarantee a portion of the loan, making it more attractive to lenders.

For more insights, see: Business Plan for Financing

Crowdfunding is a low-risk option for business owners, as you retain full control of your company and are not obligated to repay crowdfunders if your plan fails. Crowdfunders typically expect a "gift" from your company, such as the product you plan to sell or special perks.

One popular use of crowdfunding is for creative works, like documentaries, or physical products, like high-tech coolers. This is because crowdfunders don't generally receive a share of ownership in the business.

To get started with crowdfunding, make sure to read the fine print and understand your full financial and legal obligations. Every crowdfunding platform is different, so do your research.

Here are some key benefits of crowdfunding: