Management fee credit facilities are loans—typically structured as revolving lines of credit—made available to the general partner or other investment management vehicle (GP/IM) of a private equity (PE) firm and secured by the management fees owed to the GP/IM by the fund’s investors. Although these facilities have been available to PE firms for the past 20 years or more, usually on a relationship basis, they have recently become more widespread as volatility in PE assets under management (AUM) has affected the fee income payable to GP/IMs.
Terms and pricing for these facilities are bespoke and will vary from manager to manager, depending on track record, fund size and other factors. Loan-to-value ratios will also change from firm to firm.
Seeing out the pandemic
Most PE firms are paid annual management fees of between 1.5% and 2% of the capital committed to the funds they manage, with the annual installments spread out quarterly or semi-annually.
Fee income is paid on this basis through the investment period of the fund (usually five years or less). Once a fund is through its investment period, fees are then calculated according to either the value of the fund’s AUM or the amount of capital actually invested.
These management fees are distinct from carried interest—which is a percentage of returns (usually 20%) paid to the GP/IM or a related carried interest vehicle after an agreed return hurdle rate (typically around 8%) has been met. By nature, payment of carried interest occurs late in a fund’s lifecycle as assets are realized.
Management fees thus provide managers with the predictable payments required to cover a firm’s running costs, such as overhead, salaries for the GP/IM’s investment professionals and other general operating costs, until the larger carry payouts fall due at the end of a fund’s life.
COVID-19, however, disrupted these steady management fee income streams, especially for funds past their investment periods. For firms relying on fee payments linked to AUM, the temporary declines in asset values that occurred in the early stages of the pandemic had a direct impact on fees receivable.
According to McKinsey, stakes in PE funds were trading at an average of 80% of net asset value (NAV) in the PE secondaries market through the first wave of lockdowns. Asset valuations have recovered subsequently, but as NAVs have fluctuated, so have the proceeds from management fee income.
For many PE managers the impact of COVID-driven management fee fluctuations has been compounded by normal fund lifecycle considerations. PE exit activity was robust in 2020, despite the pandemic. Exit value for 2020 came in at US$251.2 billion, up from US$180.85 billion in 2019, representing the highest annual exit value this decade according to data from Mergermarket. As funds come to the end of their life and assets are harvested, associated management fees naturally decline alongside the dwindling AUM.
For PE managers, the past 12 months have highlighted the benefits of management fee credit facilities. They provide access to finance based on anticipated fee income and have given managers the room to ride out periods of uncertainty. Managers with management fee credit facilities in place have been able to smooth their cash flows and make sure they have the liquidity to cover overheads.
Longer-term drivers are also involved. For example, fund sizes have increased over the past decade. According to Pitchbook, 145 US PE firms closed funds in 2010, raising a total of US$58.2 billion. In 2020, US fund volumes came in at 231 funds—a 59% increase over 2010—while total fund value increased by 71% to US$203.2 billion. Moreover, while average fund size has increased, the amount of capital investors expect the manager to invest in new funds (historically 1% of the overall fund commitments) has also increased, reaching as much as 5% for some funds.
As a consequence, PE dealmakers require ever greater liquidity in order to finance their own commitments to the funds they manage. By enabling PE managers to monetize the expected management fee income stream from one or a portfolio of funds, management fee credit facilities help financial sponsors to cover the upfront outlay when making commitments to a newly raised fund.
Bank appeal
For lenders, expanding the provision of these specialist facilities helps lock in market share for other PE fund focused financing products. There is also limited competition from conventional business lenders, who are less familiar with the nuances and timelines of the PE firm earnings profile.
Management fee credit facilities are not loss-leading offers, but lenders advancing capital against management fee income can gain unique insight into the economics of a PE firm, its business model and future fundraising plans. This knowledge of a client puts a lender in pole position to win further business from general partners with NAV facilities, subscription line loans, partner loan programs and private wealth management services to a firm’s dealmakers.
The strategic value for banks in providing management fee credit facilities coupled with growing demand from PE firms for the product are expected to support its ongoing popularity as PE moves on from the disruption of the past 12 months.