In-person client presentations have taken a break over the past year, but when they have happened the question always comes up, “Do you see a lot of management fees these days?” The answer to that question was, “They’re still not that common, but we’re starting more to see. ”Gaining momentum is still the right answer. This trend has continued during the break and while we’re not ready to say they are common, we certainly continue to see a higher percentage of them.
With that in mind, it would make sense to take another look at the management fee lines – what they are, what they are not, and what are (or should be) the actuarial pillars of a management company loan.
Fund financing Friday has already dealt with the “micro” issues related to credit lines for management fees (“management fee lines”), so the goal here is to offer a more “macro” view of how we think about management fee lines on the legal side from a legal perspective / credit / conceptual point of view – more of a 101-level approach than a graduate-level approach.
From a credit and conceptual point of view, underwriting lines (“subscription lines”) and management fee lines are typically covered by the same bankers and they are both loans “to private equity funds”, but from our perspective this is mostly the case as the similarities end .
What is an Administration Fee Line and how is it different from a Subscription Line? How are Management Fee Lines and Subscription Lines (and similar) different from the other types of loans that lenders give not only to private equity funds but also to goods and service companies?
Management fee lines vs. subscription lines
There are marked structural differences in who the borrower is / provides the loan and what the collateral is, as well as obvious (or not-so-obvious) credit / conceptual differences in terms of a lender’s repayment in terms of management fee lines and Subscription Lines. On a typical underwriting line, the borrower is a Fund while on a management fee line the borrower is the general partner or management company of a fund (or typically a series of funds) (collectively the “Management Company”). The security on a subscription line is the unclaimed capital of the Fund’s investors and the security on a management fee line is that Operating profit / cash flow the management company – the income it generates from managing the fund.
Management Fee Lines and Subscription Lines vs. General Corporate Credit Lines
Different institutions and law firms categorize the lending business equally (business sectors versus loan size, etc.), but at the most basic level there are three types of loan: (i) investment grade / unsecured facilities (“IG Facilities”), (ii) asset-based loan facilities (“ABL Facilities”) and (iii) Non-Investment Grade / Secured Facilities (“Cash Flow Facilities”).
Here is a summary at a 30,000-foot level: (i) IG facilities are for very good companies with large balance sheets with very little risk of repayment to the lender and therefore low interest rates; (ii) ABL facilities are intended for corporations but are backed only by the financed assets (typically not “all assets”) with a certain type of credit base and advance interest assuming a reasonable cushion of security, leaving the lender with very little risk of repayment and thus have an interest rate that matches the quality of the collateral (not necessarily the quality of the borrower); and (iii) cash flow facilities are for companies that typically have higher levels of debt than income and / or new or uncertain credit history. While a lender is typically backed by all of the company’s material assets in a cash flow facility, the liquidation value of the company’s assets would not necessarily cover the amount of the facility and the lender looks primarily for cash flow from operating activities as the primary one Source of repayment. As a result, a cash flow facility has a higher interest rate because the ultimate risk of repayment to the lender is much greater than that of an IG facility or an ABL facility.
In the early years of the subscription lines, the parties involved would likely have viewed them as IG facilities as, although backed by the fund’s uncalled capital, they were primarily relationship loans given only to a lender’s leading private equity clients were reserved. In that way, and on that day, Subscription Lines would arguably have been seen as an extension of a lender’s cash management services, as well as a way to facilitate the lender’s ability to hedge future lending activities, particularly the more lucrative acquisition finance business of these private equity firms. Customers. Any default risk was further reduced when looking at the reputational damage such an event would inflict on a leading private equity client, let alone its ability to maintain access to finance.
Today, subscription lines are more like ABL facilities. You have a credit base that reflects an advance rate on the collateral (uncalled capital) and credit risk is somewhat (but not entirely) separate from the business of the fund. It has often been said that traditional ABL facility lenders do not care about the borrower’s business; all they care about is that the collateral is funded and that it is paid in full upon liquidation. Similarly, a fund is not an operating business in the traditional sense, and while the fund’s success certainly serves as an incentive for investors to fund capital commitments and is a potential secondary source of repayment, a subscription line lender is not primarily looking for the fund’s cash flow as a major source of repayment.
Historically, the management fee lines would have been similar to IG Facilities – main sponsors had the balance sheets and the credit to repay their loans, and reputational damage would have been a big part of avoiding loan defaults. Today management fee lines would be referred to as cash flow facilities. Relationships are still important, but few would consider drawing lines as “accommodations” for high-quality private equity clients or simply as a means of promoting the funding of those clients’ acquisitions business.
The comparison is not perfect, but conceptually it is better to view Management Fee Lines as the profile of a Cash Flow Loan than an “ABL Facility-like” Subscription Line – offices and printers are rented and the lender is dependent on the management company for payment Receive loan repayment services. Subscription lines and management fee lines are both to a private equity firm (one for the actual fund, the other for the fund’s management company), both are collateralized, and the management fee line may even have arrangements that increase the value of the collateral (ie, the operating income / cash flows from the funds), which makes it appear similar to a subscription line. In essence, however, a management fee line is very different. Unlike a underwriting line which relies on a pool of collateral which is in some ways different from the operation / performance of the Fund, the main source of repayment of a management fee line is the cash flow from the operations of the management company, similar to a cash flow facility.
As a result, access to the “cash flow collateral” depends directly on the performance history, management experience and ongoing functionality of the management company. Even more than a cash flow facility for a traditional operating company that is likely to have some liquidation value (assets or “enterprise value” even for service business) within a management company, even if the management fee line through “all assets” is the reality The customer base (and its claims) are only as diverse as the (likely related) funds it manages. In addition, in terms of enterprise value, a management company is unlikely to be sold as a going concern or to retain its only assets – the management contracts and the professionals who provide the services to the funds.
While the foregoing may appear to be a negative assessment of the Management Fee Lines, it is not by design. For many reasons, including a strong track record, significant management experience, and continued operational success, management fee lines can provide a very high probability of repayment to a lender, unlike the thousands of cash flow facilities that are given to operating companies on a daily basis. The point is that they are strikingly different from subscription lines and should be looked at and reviewed accordingly.