The use of subscription lines of credit by private equity funds could complicate the process of selling a limited partnership stake in a secondaries transaction, according to Howard Marks, co-chairman of Oaktree Capital Management.
Credit lines are secured against the LPs in the fund and “since each LP’s commitment to the fund is an essential part of the bank’s collateral, the existence of a line could conceivably complicate the process of selling an LP interest in a secondary transaction, in particular if the would-be buyer is less creditworthy,” Marks wrote in a memo published on the Los Angeles-headquartered asset management firm’s website.
Marks also warned of the obfuscating effect on declared performance presented by subscription lines, another potentially complicating factor for secondaries.
“Provocatively, a fund that used a subscription line and came in with a high IRR [internal rate of return] may not have done as good a job – or made its LPs as much money – as one that didn’t use a line (or used a line less extensively) and reported a lower IRR,” he wrote.
“The bottom line on all this is that the use of subscription lines sheds considerable doubt on the significance of IRR. And when IRR becomes suspect, anyone wanting to evaluate fund results has no choice but to put greater emphasis on the multiple of capital.”
However, one private equity advisor told Secondaries Investor that subscription lines should not interfere with the process of selling a fund interest because the lines are secured against the full LP base, not individual LPs.
“Most of the subscription lines are, in theory, secured by capital calls from all LPs, not just a few, and therefore, are an assumed obligation of successor LPs in the event of sale,” said David Fann, chief executive of TorreyCove Capital Partners. “As with all transfers, the GP needs to make sure they are comfortable with new LPs that come in through the secondary process.”