Private Equity Managers Are Increasingly Turning to Loans Instead of Investors

Almost half of private equity funds launched this decade have used subscription credit lines to fund deals, Preqin data show.

Illustration by II

Illustration by II

Use of subscription credit lines — short-term loans used to fund deals — has more than tripled among private equity funds, according to a new report from alternatives data firm Preqin.

According to Preqin, 47 percent of private equity funds launched in 2010 and later have utilized subscription credit facilities. By comparison, just 13 percent of funds launched before 2010 used the short-term financing tool.

Subscription credit lines are typically used by fund general partners in order to delay calling in committed capital from their limited partners, or investors. It’s a practice that critics such as Oaktree Capital Group co-chairman Howard Marks and the Institutional Limited Partner’s Association have warned could artificially inflate performance figures.

“With calls of LP capital postponed, the reported internal rate of return or IRR in the early years — the dollar-weighted return on LP capital — will increase substantially,” Marks argued in a 2017 memo. “All other things being equal, the fund’s lifetime IRR will remain higher than it otherwise would have been.”

However, recent analysis by private-markets data firm PitchBook suggested this may not be the case. After studying performance figures of private equity funds from vintages ranging from pre-2000 to the period between 2012 and 2015, PitchBook analysts did not find “any evidence that IRR is being distorted for funds of more recent vintages.”

[II Deep Dive: Are Private Equity Firms Inflating Their Returns?]

The “wide range of opinions between and among both fund managers and investors” regarding the use of subscription credit facilities has made the financing tool “something of a hot button issue,” according to Justin Hall, a product manager at Preqin.

“While they can offer more liquidity and easier cash flow management to investors, they can also make it more difficult to evaluate portfolio performance and do due diligence on prospective managers’ previous funds,” Hall said in a statement. “These drawbacks may fade as reliance on IRR figures diminishes, but that is unlikely to dispel investors’ unease completely.”

Beyond private equity, Preqin also found growing adoption of subscription credit among venture capital, private debt, and real assets funds. Subscription credit usage was not up among real estate funds, but a majority of these funds were already using the financing tool for funds launched before 2010, according to the data.

Overall, Preqin said that 52 percent of 2015-vintage private capital vehicles and 53 percent of 2016-vintage funds had used subscription credit lines, up from just 26 percent in 2010.