Our approach is borne out of experience

Introduction

Subscription facilities are lines of credit that private equity funds use to finance their investments. They can offer several advantages, such as faster deal execution, lower capital calls, and enhanced returns. However, they also come with certain costs and risks, such as interest expenses, covenants, and potential conflicts of interest. Therefore, it is crucial for fund managers to negotiate the best possible terms for their subscription facilities.

Intro: In this article, we will explore how Anzere Advisory, a leading advisory firm specialized in subscription facilities, helps its clients achieve better outcomes in their negotiations with lenders. We will discuss some of the key pricing levers that we use to optimize the cost and value of subscription facilities for its clients. We will also share some of the best practices and tips that Anzere follows to ensure a smooth and successful negotiation process. By reading this article, you will learn how we can help you secure the most favourable subscription facility for your fund.

We look at how the different levers work to influence the terms

Pricing levers are factors that affect the cost and value of a loan for both lenders and borrowers. They can be used to adjust the pricing of a loan based on market conditions, risk profiles, and strategic objectives. By using pricing levers, lenders and borrowers can negotiate loan terms that are more favourable and aligned with their interests.

Some examples of pricing levers are:

• Price-flex or market-flex: This allows arrangers to change the pricing of a loan based on investor demand—in some cases within a predetermined range—as well as shift amounts between various tranches of a loan. This can help lenders to attract more investors and reduce their exposure, while borrowers can benefit from lower interest rates and fees if the demand is high.

• Margin ratchet: This is a mechanism that adjusts the interest rate margin according to certain performance indicators, such as leverage ratio, EBITDA, or credit rating. This can incentivize borrowers to improve their financial performance and reward them with lower interest costs, while lenders can protect themselves from deterioration in credit quality and increase their returns.

• Contract extensions: This is an option that allows borrowers to extend the maturity date of their loan by paying a fee or accepting a higher interest rate. This can provide borrowers with more flexibility and liquidity, while lenders can earn more interest income and retain their customers.

Pricing levers are important for negotiating loan terms because they can create value for both parties and enhance the efficiency and effectiveness of the negotiation process. By using pricing levers, lenders and borrowers can achieve better outcomes that reflect their preferences and goals.

Negotiating every aspect of Subscription facilities is what we do best

• Negotiating interest rate: One of the most important pricing levers in subscription facilities is the interest rate, which determines how much the fund has to pay for using the credit line. The interest rate consists of two components: the base rate (usually LIBOR) and the margin (the spread over the base rate). We help our clients negotiate on just the margin as usually base rate is determined by external financial market conditions.

• Margin: We utilize margin ratchet mechanisms, which adjust the margin according to certain performance indicators, such as leverage ratio, EBITDA, credit rating, or ESG metrics. This means that if the fund performs well and meets or exceeds certain thresholds, the margin will decrease and vice versa. We help our clients set realistic and achievable targets for the margin ratchet, based on their historical and projected performance. We also help our clients negotiate favourable definitions and calculations for the performance indicators, as well as appropriate grace periods and cure rights for any breaches.

• We also utilize all the tools available to negotiate facilities with ESG-linked terms, which can lower the margin if the fund hits certain ESG metrics. These metrics can be related to environmental, social, or governance aspects of the fund’s portfolio companies or operations. We help our clients to identify and measure their ESG performance and align it with their lenders’ expectations and standards. We also help its clients communicate their ESG achievements and challenges to their lenders and stakeholders.

• Repayment schedule: Another important pricing lever in subscription facilities is the repayment schedule, which determines when and how the fund must repay the principal amount of the loan. The repayment schedule can vary depending on the type and duration of the facility, such as revolving, term, or bridge. We help our clients negotiate the repayment schedule that suits their cash flow and investment needs.

• Revolving facilities: We need to negotiate the availability period, which is the time frame during which the fund can draw down and repay the facility at its discretion. The commitment fee is usually paid on undrawn funds and we look to minimise this as much as possible as it usually costs the bank very little to provide commitment on these types of facilities.

• Term facilities: We want to make the amortization schedule as efficient as possible, which is the schedule of principal repayments over the life of the facility. We will look at the prepayment fee, which is the fee paid to the lenders for repaying the facility before its maturity date and get this lowered or removed. This depends heavily on the fund’s expected cash flow and exit strategy.

• Bridge facilities: We can help clients to negotiate the maturity date, which is the date by which the fund must repay the facility in full or look to include an extension option, which would extend the maturity date but usually involve paying a fee or accepting a higher interest rate. That balance between the maturity date and the extension option is a tricky one to get right and depends on the expected refinancing or repayment sources.

We will also consider and negotiate default, prepayment, and other key covenants - these clauses can have a significant impact on the risk and value of the facility for both parties.

Conclusion

In this article, we have explained what subscription facilities are and why they are important for private equity funds. We have also introduced the concept of pricing levers and how they can be used to adjust the cost and value of subscription facilities. We have then explored the specifics of negotiation and how we use pricing levers to optimize the interest rate, the repayment schedule, and the default, prepayment, and covenant clauses. We have also shared some of the best practices and tips that can be followed to ensure a smooth and successful negotiation process.

We hope that this article has given you some insights into how we negotiate subscription facilities for our clients. We believe that by using pricing levers, we can create value for both lenders and borrowers and enhance the efficiency and effectiveness of the negotiation process. We also believe that by incorporating ESG factors into our subscription facilities, we can enhance our reputation and competitiveness in the market. If you are interested in learning more about how we can help you secure the most favourable subscription facility for your fund, please contact us today.

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