Subscription credit facilities, commonly referred to as "sub lines," are lines of credit used by private market funds to finance activities such as new investments, fees, or expenses that would otherwise be funded by capital calls from limited partners (LPs). These sub lines give the fund’s manager (the general partner, or GP) the flexibility to call capital less frequently by combining multiple cash flows into a single capital call, and they also can delay initial capital calls until a large capital outlay is required. This increases the internal rate of return (IRR) as it shortens the effective investment period. Because these sub lines are backed by investors’ capital commitments, they do not allow the GP to invest a greater amount of capital than those commitments.

Subscription lines have long been popular in the real estate sector, but they are becoming increasingly common in private credit funds and private equity. Originally used for short-term cash needs, they have evolved into longer-term financing for new investments. In a recent analysis by Preqin, it was found that only 13% of private equity funds in pre-2010 vintage years used subscription facilities, while 47% of funds in the 2010-2019 vintage years did. A similar trend was observed for private credit funds, with only 25% of pre-2010 vintage year funds using subscription facilities, versus 44% of vintage 2010 and onwards. In the same analysis, approximately half of real estate funds utilized subscription facilities in both pre-2010 vintages and vintage 2010 and onwards.

As more funds adopt subscription facilities, both GPs and LPs are spending more time thinking about the benefits and drawbacks of these products. The following are some of the advantages and disadvantages to consider:

Advantages

• Funds with a credit facility may experience a shorter and shallower J-curve because the credit facility can significantly lift the IRR, especially early in a fund’s life. This impact will be reduced as the fund matures and the credit line is paid down but may still remain elevated compared to the same hypothetical fund that did not utilize the credit line. It’s worth noting that if the portfolio has early impairments funded by the credit line, the leverage effect of the credit line will magnify those losses.
• GPs and LPs will have a reduced administrative burden from fewer capital calls.
• GPs are able to quickly draw capital from one source to close new deals, rather than calling capital over a period of several days from multiple LPs.

Disadvantages

• Net TVPI (Total Value (distributions + net asset value) divided by Paid-In capital) will be reduced due to interest and fees related to the subscription facility—in essence the short-term IRR boost comes at the expense of longer-term TVPI.
• LPs can experience delayed cash distributions due to the repayment of credit lines and GPs taking carry much sooner in the fund’s life.
• LPs have an additional layer of analysis to determine their true level of exposure in their private markets programs. LPs may also become unintentionally levered if their exposure does not correctly capture the impact of the credit line, especially if unfunded commitments are invested elsewhere.
• Some tax-exempt investors may realize unrelated business income tax, especially in longer-dated subscription facilities.
• Capital calls will be larger, which could present liquidity challenges, especially in times of stress.

Given the complexity of subscription facilities, managers may benefit from the assistance of a specialized advisor like Anzere Advisory. Anzere has extensive experience in structuring subscription facilities for European managers, with access to the whole market, and can help negotiate better terms on behalf of its clients. We consider factors beyond traditional financial metrics, including ESG considerations, when structuring these facilities. By utilizing the services of Anzere, managers can save time and money while ensuring their funds are structured in the most efficient and sustainable way possible.

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