Hi @Andy Mirza
I’ll first put a disclaimer that the only times I have seen these LOCs are for funds that raised $500MM+ and the investors are institutional (e.g., pension funds and universities). It’s possible this is done with smaller funds, but I don’t know what those terms look like (actually would be interested to hear them).
Second, I did this in a past life, so I’m not as up to date on the latest developments, this is just meant to give a high-level overview.
Third, I’ll apologize to @Bob Malecki for hijacking his thread. Watch out for Granite everyone.
Capital Call Facilities:
Most large PE funds raise money from investors, however they don't collect the cash from their investors upfront. Rather they collect signed commitment letters from investors, which say the investor will fund portions of their commitment to the Fund as requested over time. There are several reasons for this, but a main reason is that whenever the investors send cash to the fund, they are owed a certain guaranteed return (6-8%) on that amount, so funds like to manage this process and only call cash from investors when needed. However, funds then run into an issue because they need to appear to potential sellers as cash buyers, and be able to close very quickly. Calling capital from investors takes 2+ weeks usually and is an accounting mess. This is where Capital Call facilities are helpful. A bank provides the fund with a LOC, and now the fund can use that LOC to make large purchases very quickly. I've been out of this space for a bit of time, but rates were <4% (incl. LIBOR) and tenors range anywhere from 1-5 years. And then once the deal is closed, the fund will work on getting a long-term asset-level refinancing to repay the Capital Call LOC. Very similar to an investor using a HELOC to quickly purchase an asset, then going to a real estate banker to refinance the HELOC with a mortgage.
If the fund gets into trouble and can't repay, the bank has the right to turn to those investors and basically say "hey remember the commitment you are contractually obligated to send to the fund when called, well – we need to call it to pay off the LOC". If done right, the investors are already aware that this type of LOC is in place (it's usually covered in the fund's governing docs), and know they will need to fund to the lender or risk whatever repercussions are outlined in the fund docs.
Now, the reason I said I’ve only seen this with large funds with institutional investors, is because the bank is only repaid in an event of default if the investors pay up. So the bank needs to make sure the investors have significant financial wherewithal and a long track record of meeting their obligations. Obviously it’s much easier to determine this when the investors are large pension funds and schools who publish financials vs a private HNW investor.
I would categorize Capital Call facilities as more of a "bridging" facility vs true leverage. It doesn't really increase your purchasing power since the size of the LOC is based on a % of how much investor commitments have yet to be called. As the fund progresses through its life cycle it will call more and more of the investors' commitments, so the Capital Call LOC will also start reducing. But still a really useful tool if you have an institutional type fund structure. That's why I say that large institutional funds typically don't fund their purchases with cash on hand. Usually it's some form of an LOC like the above.
Hopefully that’s helpful, feel free to PM me with any specific questions. All the big banks have a team that do this, though you may have to navigate around to find the right team. Large law firms that specialize in fund formation could be another helpful resource.
