What it means
Private equity, credit and property funds raise commitments rather than cash. Investors sign up for a fixed amount and hand it over in instalments whenever the manager finds something worth buying.
A subscription line, also called a capital call facility, bridges the gap between agreeing a deal and receiving the money. The security is unusual, because it is not the fund's investments but the legal right to call unpaid commitments from the investors.
Those investors are typically pension funds, insurers and endowments with strong credit, so the facility prices far more cheaply than borrowing against the assets themselves. Banks size the line using a borrowing base, applying an advance rate to eligible uncalled commitments.
Managers like the line because it simplifies life for investors, who receive a handful of larger capital calls instead of dozens of small ones spread across the year. It also flatters the internal rate of return, since investor cash is outstanding for a shorter period.
That second point is contentious, because the reported return improves without the underlying investments performing any better. Industry practice has settled on limits in response.
Many funds now cap the facility at a stated share of total commitments and undertake to repay drawings within 90 to 180 days, and investors increasingly ask for performance to be reported both with and without the effect of the line. The risk becomes real if a fund leans on the facility too heavily.
Should several investors default on their capital calls at the same time, the bank can look to the fund's assets, forcing sales at whatever price the market offers that week.
In practice
Real-world examples.
Example
A mid market buyout fund signs an acquisition on a Friday and needs to complete within ten days. It draws $60,000,000 on its subscription line, completes on time, and issues a single capital call the following quarter that also covers two smaller deals and management fees.
Example
A property fund uses its facility to pay deposits on four warehouse purchases in the same month. Rather than four separate calls, its investors receive one notice for $95,000,000 with a fortnight's notice, which their own treasury teams strongly prefer.
Example
An investor comparing two credit funds notices one reports a 14% internal rate of return and the other 11%. Once returns are recalculated as if capital had been called on day one, the gap narrows to a single percentage point, because the first manager had been holding drawings on its line for close to a year.
Think of it
“Subscription line is borrowing against LP commitments-a bridge to capital calls.
Formula
Calculation
Available capacity = (Eligible uncalled commitments x Advance rate) - Amounts already drawn
Meridian Growth Partners IV is a $500,000,000 fund that has called 40% of commitments, leaving $500,000,000 x 0.60 = $300,000,000 uncalled. Its bank applies a 90% advance rate, so the borrowing base is $300,000,000 x 0.90 = $270,000,000, and with $70,000,000 already drawn the available capacity is $270,000,000 - $70,000,000 = $200,000,000.
The manager then draws $50,000,000 to complete an acquisition and repays it 90 days later out of a capital call. At an interest rate of 7% on a 360 day basis, the cost is $50,000,000 x 0.07 x (90 / 360) = $875,000, which is charged to the fund alongside the purchase price.Case study
Seen in the real world.
What follows is an illustrative and fictional example. Camberwell Capital Partners, an invented infrastructure manager, closed a $750,000,000 fund and arranged a subscription line of $150,000,000. In its first two years the facility did exactly what it was designed to do, letting the team move quickly on two auction processes where certainty of funds decided the winner.
Pressure appeared in year three, when the manager began leaving drawings outstanding for eleven months at a time to keep the headline return attractive ahead of raising a new fund. One investor's operations team modelled the returns without the line and found the reported 16% fell to roughly 12%, which prompted an uncomfortable conversation at the advisory committee.
Camberwell's fictional managers agreed a 180 day repayment limit and began reporting both figures side by side. Fundraising for the next vehicle took longer than planned, but the investors who did commit understood exactly what they were buying.
Watch out
Common mistakes.
- Reading a fund's internal rate of return without asking how long drawings sit on the subscription line, which can flatter the number considerably.
- Thinking the facility is secured on the fund's investments, when the real security is the right to call uncalled commitments from investors.
- Assuming the interest cost is absorbed by the manager, when it is almost always borne by the fund and therefore by the investors.
Questions
People also ask.
Does a subscription line increase an investor's total risk?
Modestly, since the same commitments now support both the investments and a bank facility that ranks ahead of them.
Why is the interest rate so low compared with other fund borrowing?
Because the lender is effectively taking credit risk on large institutional investors rather than on the fund's underlying assets.
Is a subscription line the same as an asset backed facility at the fund level?
No, an asset backed or net asset value facility is secured on the investments themselves and is priced considerably higher.
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