There’s much talk about the impact a subscription credit line can have on fund level performance. It’s generally accepted that delaying capital calls will boost internal rates of return and that the cost of a facility – even in a low interest rate environment – will have a dampening effect on the money multiple that ends up in the pocket of the investor.
Private equity advisor TorreyCove Capital Partners attempts to model what that effect would look like in practice in its report Subscription Credit Lines: Impact on GPs and LPs.
The report presents two scenarios: a ‘traditional’ equity-only investment, in which a $100 million fund is deployed in a single $100 million transaction in year one, and a $100 million fund in which a credit line is used and capital is not drawn down from investors for the first two years of the fund’s life. The second scenario assumes 100 percent debt financing of fund assets for two years, which is extreme. None of the GPs PDI has spoken with say they would leave a facility outstanding for more than 365 days.
Assuming the funds perform well – realising $200 million at the end of year six – the credit line offers an IRR boost of 300bps, while the mulitiple on invested capital was negatively affected by 0.12 turns.
The effect of the credit line is amplified if the funds make a loss. Here we see a negative impact of almost 700bps on IRR and 0.03x MOIC.
What’s more, the use of a credit line can be enough to push a fund ‘into the carry’ – even when the return on the underlying assets is not sufficient to achieve the preferred return.
In the case of a successful investment, the attractiveness or otherwise of a credit facility from an LP’s perspective comes down to which performance metric they place the most value on: IRR or money multiple. In the case of an unsuccessful investment, the downside is more obvious, regardless of which metric they favour.