Using Carried Interest As Security For a High-Value Loan

Using Carried Interest As Security For a High-Value Loan

In any deal where carried interest is used as collateral for a loan, we will need to negotiate, arrange, and structure the deal on a case-by-case basis. Using carried interest as security for a loan remains a niche type of securities-backed lending: lenders don’t offer products and there is no one-size-fits-all lending solution.

However, there are a number of benefits to this type of finance, which include allowing GPs quick access to significant liquidity that may otherwise take years to realise through a fund’s investments. This type of finance also has the benefit of not impacting the fund’s investment strategy in the sense that the fund manager continues to retain control of the fund and the fund capital, and there is no impact on the fund’s governance.

Benefits Of Using Carried Interest As Security For A Loan:

• Ability for partners to raise non-dilutive capital, avoiding a minority stake sale or management company ownership dilution
• Certainty and speed of execution: very fast access to funding allowing GPs to access liquidity that may otherwise take years to realise
• Discretion on the use of capital is maintained by the fund manager
• No impact on the fund’s governance
• A tactical and very strategic way of raising finance
• Personal guarantees from the GP(s) are not always a requirement
• Uses readily available collateral as security for the loan in the form of management fees, GP commitment and carried interest. Various debt instruments are offered by lenders (i.e., preferred equity) and repayments are structured via a relatively straightforward waterfall agreement, allowing for clarity and transparency
• Significant (multimillion pound/euro/dollar) loans available as a matter of course
• Sophisticated lenders able to work with GPs/management companies domiciled in various jurisdictions around the world
• Fixed cost of capital and repayments
• Lenders only offer bespoke and highly structured loans that are tailored to specific funding and organisational requirements: there are no products

How Do These Deals Work?

As with less ‘niche’ types of loan, a lender will carefully assess the borrower’s capital requirements and the security to make a lending decision. It is worth noting that a single GP or a GP team can access this kind of loan. In cases where an individual GP wants to raise capital, they can usually do so provided their investment and projected carried interest is large enough and there are no contractual restrictions that disbar them from doing so. Whether a single GP or a team of GPs are looking to raise capital, they will usually be looking to use this type of loan to fund or upsize new co-investments/commitments or to fund a liquidity event.

Sometimes lenders will require additional security in the form of personal guarantees, although this is dependent on the loan, borrowing scenario and the lender’s assessment of risk, and is generally decided on a case-by-case basis.

How Loan Capital Is Typically Used And What To Note

In most cases, GPs will use carried interest as security for a loan in order to fund or upsize new co-investments or commitments. In alternative cases, the GP(s) may require a liquidity event and use management fees, GP commitment or carried interest to create the capital required.

Using carried interest as security for a loan remains a highly specialised type of financing. Deals need to be arranged and structured carefully and entirely tailored to the GP(s) and their requirements for capital. This will ensure the GP team can maximise the amount they are borrowing and covers all the bases in terms of efficiency, risk, how the funds can be used, repayment, interest costs and so on. Very few lenders publicise this type of finance and usually require introductions and a broker that can work with all parties to structure the deal appropriately.

It is also worth noting that depending on where the management company and/or GPs are domiciled there may need to be differences in how the loan is structured from a legal point of view, although the mechanics of this type of financing will remain largely the same.