Subscription line of credit (SLC)

A subscription line of credit (SLC) is one of many sources of funding that general partners (GPs) can use to invest, manage, size, and time a private equity fund’s cash flow. By far, the largest source of capital is contributed by investors. Other sources of funds come in the form of debt backed by (a) uncalled capital commitment of investors, (b) proceeds available to the fund due to exits, and (c) the net asset value of the fund.

The stated purpose of SLCs is to provide liquidity for the fund. While capital calls take at least 10 days to be honored by the LPs, the liquidity provided by SLCs is available within 1-2 days. For this reason, SLCs started as short-term credit facilities for bridging of capital calls. However, they can be rolled over and, therefore, used for longer-term purposes.

SLCs represent one of several funding tools available to GPs. The flexibility offered through SLCs can be used to the benefit of both LPs and GPs. SLCs can reduce the frequency of capital calls and help GPs avoid surprise capital calls. Also, SLCs may help GPs avoid capital calls if some of the investors are facing liquidity issues.

Senior stretch loan

Senior stretch loans are hybrid loans used by middle-market firms to fund leveraged buyouts (LBOs).

These loans combine senior and junior debt into a single package and are named as such because they "stretch" to accommodate the borrower's financing needs.

The blended status of a senior stretch loan makes it higher-risk than conventional senior loans, requiring a higher interest payment to the lender.

For the borrower, the senior stretch loan provides speed and convenience, as well as savings on legal fees. The borrower does not have to negotiate separately with two different parties, the senior loan provider and the junior loan provider.

For the lender, they get flexibility, as well as an increased risk because they're now exposed to the greater overall leverage of the borrower. With this higher risk comes a higher blended interest payment to the lender.

Mezzanine Capital

Also known as subordinated debt or junior capital, mezz is sometimes used by private equity firms to reduce the amount of equity capital required to finance a leveraged buyout. These loans allow borrowers to borrow additional capital beyond the levels a traditional lender is willing to lend. Mezz lenders require higher returns because the loan is riskier, as it is junior to the senior lenders, who will recoup any losses first if there is an issue with payments.

Mezzanine Fund

PIPE (private investment in public equity)

A PIPE transaction (private investment in public equity or PIPE) is a private placement of securities of a public company that typically is made to selected accredited investors. Although PIPEs have been around for decades, they historically have been considered an expensive form of capital for issuers and an unattractive investment for many types of financial investors, especially private equity firms. As a result, traditionally only the most troubled companies were willing to raise capital through a PIPE.

However, in difficult credit environments, such as the one following the credit crisis that began in the summer of 2007, and during periods of recession, both issuers and investors are more amenable to PIPE transactions. For issuers, this is particularly true when even many healthy companies cannot access the credit markets to fund acquisitions or shore up working capital.

A tight credit environment can also force new sources of money into the PIPE market, such as private equity firms.

The carried interest tax debate

The carried interest tax rules are a set of US tax rules that offer favorable tax treatment when a partnership interest in a private equity or hedge fund in exchange for future services to the partnership. In lieu of cash compensation, the services entitle the individual to receive a share of future partnership profits.

Instead of being taxed for compensation at ordinary income tax rates, recipients of future partnership profits are usually entitled to pay tax at the long-term capital gains tax rates, which are, of course, substantially lower than ordinary income tax rates.
Under the 2017 tax reform legislation, a three-year holding period requirement applies to certain recipients in order to gain long-term capital gains treatment. President Joe Biden is proposing to permanently eliminate these carried interest tax rules so that recipients would be required to pay ordinary income tax rates on amounts received.

Funds of funds

Funds of funds are investment companies that invest in other investment companies. A fund of funds manager raises capital from investors to invest in one or more underlying funds.

Investors can rely on the fund of funds manager to identify and select managers and provide diversification to their portfolio, which would not be as readily attainable from a direct investment in PE and VC funds due to the high minimum investment level. The fund of funds managers also tend to have well-established due diligence procedures and portfolio monitoring processes and handle the negotiations with the PE or VC fund manager over fund terms, rights to information and reporting, and so on. Some fund of funds managers may have related businesses that invest in PE and VC "secondary fund" interests, which are existing fund interests acquired from other LPs. Some funds of funds or other LPs may also co-invest (invest directly in an underlying portfolio company) side by side with the fund making a direct investment.

Exit Opportunities

Portfolio companies may pursue numerous alternative paths to exit, including going public, divestitures or spin offs, recapitalization, merging with other companies, or downsizing in an attempt to transform, all of which can happen within the span of one fund's ownership.

However, at every stage in the process, the fund manager must continue to focus on an ultimate exit strategy, despite the potential for that strategy to change based on dynamic market conditions.