United States: Qualified Borrowers: An Advantageous Way For Portfolio Companies To Access Capital

A qualified borrower is a portfolio company that is qualified by the lender to borrow under the subscription credit facility for its parent fund. 

Many portfolio companies¹ are experiencing operational and financial challenges like never before. Fortunately, there is a way for portfolio companies to access capital on competitive terms, even if they are subject to an "all assets" lien and restrictions under an existing credit facility: as qualified borrowers on the subscription credit facility for a parent fund.

Qualified Borrowers

A qualified borrower is a portfolio company that is qualified by the lender to borrow under the subscription credit facility for its parent fund. Oftentimes, the fund's subscription credit facility agreement allows the fund to add portfolio companies as qualified borrowers through a joinder to the credit agreement. This joinder is usually subject to satisfactory completion of diligence on the portfolio company by the lender, as well as delivery of the following from or on behalf of the portfolio company to the lender: (i) organizational documents, (ii) resolutions authorizing borrowings, (iii) a promissory note, (iv) a legal opinion and (v) more (e.g., applicable deliverables depending on the jurisdiction of organization of the portfolio company). After the joinder, the portfolio company is able to borrow under the credit facility to the same extent as the parent fund and any other co-borrowers under the credit facility. In exchange for this flexibility, the fund also executes a guarantee agreement in favor of the lender whereby the fund unconditionally guarantees repayment of the portfolio company's borrowings if the portfolio company fails to pay. A qualified borrower is only liable for its own borrowings and is not liable for the borrowings of its parent fund or other borrowers on the subscription credit facility.

Advantages to Using Qualified Borrowers

First, as a qualified borrower under a fund-level subscription credit facility, a portfolio company does not need to put up any of its own assets to be able to borrow money. The portfolio company can borrow under the subscription credit facility on an unsecured basis as to its own assets. Instead, the portfolio company's borrowings are secured by the fund's collateral ((i) unfunded capital commitments of the limited partners of the fund, (ii) related rights of the fund and its general partner (e.g., to make capital calls and to enforce payment of the same) and (iii) collateral accounts into capital contributions are made).

Second, qualified borrowers are able to borrow money on the same terms as their private equity fund parent because the same collateral secures borrowings at each level. Because subscription credit facilities are typically secured by high credit quality collateral and have a near-zero default rate historically, the pricing and applicable interest rate for borrowings are often quite competitive. Accordingly, a portfolio company that is a qualified borrower under the subscription credit facility for its parent fund may be able to borrow money and/or refinance asset-level debt with cheaper debt borrowed from the fund-level facility.

Third, using qualified borrower capability can reduce administrative burden, time and expense for the fund and portfolio company alike, as well as streamline transactions and fund operations. The qualified borrower can borrow directly from the fund-level facility, instead of the fund having to borrow and then loan or contribute capital to the portfolio company in separate transactions. Borrowings can occur under one set of credit facility documents that can be prepared by one law firm, rather than two sets of documents potentially prepared by two law firms.

Finally, even if private equity sponsors² have sufficient cash on hand, they may not want to make a cash infusion into a particular portfolio company now for a variety of strategic, tax or other reasons. A sponsor may also be reluctant to call capital from its funds' partners at this time for strategic, relationship or other reasons. The qualified borrower joinder mechanism is a useful way to enable liquidity-starved and/or fully leveraged portfolio companies to easily obtain capital to meet their financial needs and achieve their business objectives without sponsors contributing capital directly or funds calling capital and then contributing the capital to the portfolio company.

The Current Market

The COVID-19 pandemic has extensively strained liquidity for many portfolio companies. Sponsors seeking to inject liquidity into their adversely affected portfolio companies may want to take advantage of any qualified borrower joinder mechanism in their funds' subscription credit facilities. This mechanism can enable portfolio companies to draw on the subscription credit facilities of their parent fund to access capital that may not otherwise be available (or only available on undesirable terms) and navigate through these extraordinary times. Qualified borrower capability provides an efficient and advantageous way for portfolio companies to access capital, with distinct benefits over asset-level financing alternatives.

Footnotes

1. As the term is used herein, "portfolio companies" are entities (typically companies with operations and employees) in which a private equity investment fund sponsor directly or indirectly invests. Such companies are referred to as "portfolio companies" because all such companies collectively comprise the investment portfolio of the applicable sponsor.

2. As the term is used herein, a "sponsor" is an investment firm that financially sponsors or supports an investment (e.g., in portfolio companies). An entity is "sponsored" when it has such a firm directly or indirectly (e.g., through holding companies and investment fund entities) backing its finances and managing its operations. Sponsors that invest in the equity of privately held operating companies ("private equity sponsors") seek to grow and/or improve the operations of such companies, typically over a multiple-year term, with a plan to eventually divest such investment at a profit.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.