Although they only appeared on the French market in 2012, the use of equity bridge facilities (EBFs) by French Funds has increased progressively. There are a number of reasons why this financing tool is so popular.
In line with foreign private equity funds, French funds are very interested in bridge-financing capital calls to their investors. Whether referred to as an EBF, subscription facility or capital call facility, this type of credit facility is aimed at pre- financing investors’ capital in the fund in order to rationalise capital calls.
Depending on the borrower’s administrative, regulatory or contractual burdens, an EBF can be structured as a revolving credit facility or a term facility, on a confirmed or non-confirmed basis, and made available by one or more banks. Regardless, the EBF will be secured by the uncalled capital of the investors.
Many fund managers believe EBFs allow French funds to compete on a level- playing field with foreign funds.
Although the tool only appeared on the French market in 2012, the number of EBFs in use by French Funds has progressively increased and EBFs have become extremely popular.
One of the main reasons for the popularity of EBFs is their flexibility, as the credit can be made available either by cash advances, or as letters of credit or bank guarantees. An EBF therefore fulfils all the fund’s needs, while at the same time ensuring the administrative and financial rationalisation of capital calls.
The evolution of the traditional financing structures used in the US and the UK markets allowed the “French style EBF” to be perfectly adapted to French regulations and to the French transposition of the Alternative Investment Fund Managers (AIFM) Directive. It is important to highlight that the EBF, as bridge-financing of the capital, does not qualify as leveraged financing under the AIFM regulation, as long as it complies with certain conditions. It must
- Be a temporary, non-revolving credit facility Have a drawing maturity of less than 365 days
- Have a repayment obligation secured by the uncalled capital commitments of the investors.
The main benefits of establishing an EBF are shared by the fund, its management company and the investors themselves. The benefits include
- The speeding-up of the disbursement of funds
- The rationalisation of capital calls
- The limited costs of financing.
The EBF deploys funds much faster than direct capital calls, which require approximately 10 to 15 business days. This translates into a significant advantage when selecting financial partners. A rapid and flexible mobilisation of capital resources can be the key to a favourable outcome of a transaction in the private equity market, which has become more and more competitive.
Such quick access to capital, combined with a flexible voluntary repayment method, make the EBF one of the most efficient instruments in the management of capital calls. The EBF allows the management company to “concentrate” capital calls on fixed dates (every three months, six months or annually) by pre- financing through loans the intermediary closings and the management costs.
Not only can investors take direct advantage of this rationalisation of capital calls, as it simplifies the administrative management of their fund participations, but management companies can also use them to decrease the number of capital calls, which are often too frequent and for a small amount.
Another positive aspect to the rationalisation of capital calls is the fact that an EBF can be achieved by letters of credit or bank guarantees. Letters of credit or bank guarantees, as opposed to capital calls, provide the opportunity to raise capital as security for future payments, an advantage that is highly appreciated by infrastructure and real estate funds. Instead of disbursing funds as a guarantee of payment in construction or investment operations, the funds with an EBF would rather ask for a bank guarantee to be granted so investor capital is not used or locked, thereby improving the performance of the fund.
EBFs, which are not asset backed facilities, but are instead mainly secured on the investors’ uncalled capital, are attractively priced. The European margin level of this “low-cost” financing varies from 150 to 200 basis points, and the arrangement fees, which are usually not paid up front but in several instalments on each anniversary date of the facility, vary from 15 to 30 annual basis points, depending on the amount and the maturity of the EBF.
A RISK MANAGED BY THE LENDERS
The risk exposure of lenders under an EBF is different to the risk exposure under an asset-backed financing. In the latter, the risk of a payment default by the lenders is based on the performance of its underlying asset(s) at the end of a three to six year period, depending on the type of credit.
Under an EBF, the lender’s credit risk is calculated based on the investors allowing the lenders to exercise their rights to call in the capital after a payment default.
Lenders attribute a rating to each investor in order to take into account their own credit risk. This rating (together with an affiliate percentage) is applied to their uncalled commitments to determine the portion of the uncalled capital to be included in the global calculation of their coverage ratio. For the best-rated investors, this ratio is between 90 to 95 per cent of the uncalled commitment, whereas only a small percentage is retained for the lower-rated investors. The quality and the credit rating of each investor should therefore be assessed individually in order to evaluate the global credit risk of the EBF. For instance, a lender could request for the investors’ uncalled capital to represent a minimum of 150 to 200 per cent of the EBF principal amount.
Such a risk calculation combined with short-term drawings (364 days maximum) gives lenders more visibility on their real risk, and enables them to offer margins that are extremely competitive in comparison with other types of financings.
As a result of its relatively low cost, the benefits it renders and the optimised administrative and financial efficiency of the capital calls, the EBF has emerged as a key instrument in French fund management.