Capital call facilities, also known as subscription finance facilities, are a fund finance solution that has become a mainstream tool for private capital sponsors across strategies including buyouts, private credit, venture, real estate and infrastructure. In this primer we provide a high-level introduction to these credit facilities in three parts: 1) a general overview, 2) a look at structuring considerations and other uses, and 3) a review of fund structures and documentation considerations.

Part 1: Overview

What is a capital call facility and why use one?

A capital call facility is a line of credit provided to a fund to bridge investments or for other temporary funding purposes. With the liquidity provided by the facilities, managers gain funding flexibility and certainty, coupled with operational relief by allowing for the “smoothing” of capital calls from investors. Capital call facilities are also commonly used to support working capital needs, issue letters of credit, manage hedging and reduce the need for “true-ups” between fundraising closes.

When is the right time to start the process?

Capital call facilities can be put in place throughout a fund’s investment period. However, it is generally best to start the conversation with a lawyer and bankers during the fund formation and fundraising process to gain an understanding on facility structures available and their mechanics. This knowledge enables fund managers to be in a stronger position to discuss financing plans with prospective investors.

Key transaction terms and structure

Facility types: Committed or uncommitted revolving lines of credit.

Facility sizing: There is a range of factors that go into determining facility size, such as expected capital deployment timelines, preferred frequency of investor capital calls, and Limited Partnership Agreement (LPA) limitations. Generally, the sizing of a facility will be discussed as a percentage of total investor commitments and governed similarly by the LPA. For example, a common LPA formulation is to limit fund indebtedness to the lesser of 1) 25% to aggregate investor commitments and 2) remaining uncalled capital. Another common approach to facility sizing is for it to be determined by typical investment size, where a manager may seek capacity to fund, for example, between one and three transactions at any one time.

Facility availability: Capital call facilities are a type of “asset-based loan” where the key financial covenant, commonly referred to as the borrowing base, also governs the facility availability. Borrowing base availability is derived from a fund’s remaining uncalled capital, typically determined by either an advance rate(s) or a coverage ratio (one being the inverse of the other). The two most common approaches to advance rates are flat advance rates (e.g., 50%) across all investors or where investors are categorized and given different advance rates based on perceived credit quality (e.g., Included: 90%, Designated: 65% and Excluded: 0%). The example below provides a simple illustration of how availability calculations operate for a borrowing base with a 50% flat advance rate, equivalent to a 2.0x coverage ratio.

In addition to advance rates, there are additional factors that can impact a facility’s borrowing availability. These tend to relate to conditions that can reduce the amount of uncalled capital that is “eligible” in the determination of availability calculations. Such factors may include:

• Investor concentration limits: These limits may be applied against individual investors, or classes of investors, to set restrictions on the amount of the borrowing base composed of the uncalled capital commitments of any single investor or class of investors. Amounts in excess of the concentration limit will be excluded from Eligible Uncalled Capital.
• Inclusion criteria: Some lenders will not automatically advance against each investor’s unfunded commitment and instead will set specific inclusion criteria that an investor must meet in order for its commitment to be included. Individual investor inclusion criteria may include a combination of the investor’s external credit ratings, total net worth or other credit underwriting criteria. Lenders will often retain ultimate discretion to include investors irrespective of whether an investor meets the set criteria. If any investor does not meet the set inclusion criteria, it may not be included in Eligible Uncalled Capital.
• Exclusion events: These are events that occur following the facility close that may result in an investor being removed from Eligible Uncalled Capital. Exclusion events may occur when an investor: defaults on their commitments, transfers their commitment, is subject to a bankruptcy proceeding, has a material impairment in their ability to fund their capital commitment, or disputes their obligations to fund remaining commitments. Exclusion criteria can result in temporary or permanent exclusion of an investor’s commitment in Eligible Uncalled Capital.
  

  Below is an example of how the above factors may impact borrowing availability:

  (a) Remaining Uncalled Capital	80.0	60.0	40.0	20.0
  (b) Exclusions/Concentrations	(10.0)	(7.5)	(5.0)	(2.5)
  (c) Eligible Uncalled Capital	70.0	52.5	35.0	17.5
  (d) Borrowing Base at 50% of (c)	35.0	26.3	17.5	8.8
  (e) Facility Limit	20.0	20.0	20.0	20.0
  Borrowing Capacity The lesser of (b) and (c)	20.0	20.0	17.5	8.8

• Advance periods: A fund’s LPA and/or the credit facility will often include limitations on the length of individual borrowings (e.g., 180 days) to ensure that proceeds are being used for bridging purposes. These advance periods, also referred to as “clean-downs,” do not require the facility balance be reduced to zero, but require that each draw under the facility be matched to the days outstanding.
• Security/collateral: The breadth of security structures can vary from transaction to transaction. However, the key focus of lenders will be on perfecting an exclusive pledge over investors’ capital commitments, the fund’s bank accounts and the general partner’s right to call and enforce capital commitments.

This concludes Part 1 of First Republic’s three-part primer on capital call credit facilities. Review the full report for details on structuring capital call facilities, fund structures and documentation considerations.

The content of this publication is for information purposes only and should not be considered as a commitment to lend or as legal, financial, accounting or tax advice. First Republic Bank makes no representations, warranties, or other guarantees of any kind as to the accuracy, completeness or timeliness of the information provided in this publication. You should consult with your own professional advisors to fully understand and evaluate the information provided in this publication before making any decision that could affect the legal or financial health of your business.