Zac Barnett is a Chicago-based attorney and co-founder of Fund Finance Partners, LLC, where he has spent two decades structuring subscription, hybrid, NAV, and other bespoke facilities for private-equity sponsors and their funds. Having closed more than 500 transactions representing over $250 billion in aggregate lender commitments, Barnett is widely regarded for helping general partners access flexible, compliant financing that aligns investor, sponsor, and lender objectives.
In 2023, 25 fund managers raised 41 percent of the capital, revealing the increased demand for private equity, private credit, and other financing vehicles and illustrating the demand for alternative methods for raising capital. Some of this fundraising happens through financing, such as general partner (GP) debt financing through various debt structures, which offers multiple benefits.
GPs raise funds by securing capital from a lender, such as a banking institution or other investors. The debt structure consists of one loan to the GP or multiple loans disbursed to those directly involved with the GP or fund manager, where the fund manager guarantees individual loans.
Moreover, GP debt financing can include lines of credit, which enable the GP to pay for expenses and manage the portfolio, company, or asset. They can obtain a management fee line of credit designed specifically for GPs to pay management fees related to the fund’s operational costs. Then, net asset value (NAV) debt enables the GP to borrow based on the value of the fund’s assets. An unencumbered asset pool uses assets without liens, restrictions, or financial obligations as collateral against the loan.
Additionally, fund managers might rely on capital calls, which involve asking investors to commit to investing more capital to bridge the gap between the money needed and current contributions. GPs can also borrow through partner loan programs, which involves individual partners within a GP borrowing from one another to meet their capital commitments. Finally, GPs can use debt to finance investments by combining NAV with capital calls.
This financing strategy has emerged in investing circles for a few reasons. With inflation and other economic factors, experts state that GPs must raise more money to meet commitments. More importantly, as opportunities to invest in potentially lucrative companies arise, GPs must tap into alternative investment vehicles to meet these financing needs or miss out on investments that could generate large sums for investors.
Regardless of the approach to using debt to finance an investment, GP debt financing gives those GPs access to capital, which is a primary benefit. This access prevents them from having to commit their funds. Furthermore, GP debt financing enables GPs to hold onto their share of investment and raise funds, which they cannot do in equity investing. Additionally, GPs can customize funds to align with the companies’ cash flow, distributions, and portfolio exits when the investors stop investing in a company, whether through asset sale, raising shares through initial public offering, liquidation, or management buyout.
Customizing the fund ensures that the money used to repay the debt is enough to cover the liquid assets. It allows GPs to explore other ways of strategically creating growth, whether through a company, succession planning, or expanding the fund’s services. Finally, GPs benefit from tax-deductible interest payments.
While this approach to GP debt financing is flexible and offers several benefits, it also comes with a few caveats. GPs intensify losses if their investments perform poorly because of GP leverage (the amount borrowed to manage the fund). GPs also risk interest rate hikes and loss of credibility.
Furthermore, GPs might find their ability to tap into capital strained because repayment obligations create a situation where assets are not liquid. Illiquidity creates a situation where GPs cannot access funding for other investments. High fund fees combined with interest payments can erode returns made from the investment. In some states and countries, GPs face stringent compliance regulations that can interfere with obtaining financing through a debt vehicle. Finally, if the fund’s returns are under pressure, this impact might create friction between the limited partners and fund managers.