Crestline: Better documentation of portfolio finance in LPAs

Last week Fort Worth-based Crestline Investors announced the final close on $600 million for its first dedicated vehicle targeting portfolio financing opportunities for private equity funds.

Crestline Portfolio Finance Fund will provide acquisition financing, growth capital, debt refinancing and covenant breach cures for lower and mid-market vehicles globally.

Sister publication Private Equity International caught up with senior portfolio manager David Philipp, who co-leads the strategy, to discuss the factors driving the move.

Why did you launch this strategy?

We’ve seen a number of managers reach out to us now in anticipation of establishing some type of line and facility if and when the market pulls back. Over the last six months people have been thinking a little bit more proactively about how they’ll manage the harvest period if they had access to new capital.

We’ve seen an extension in the holding period that many of the private equity funds are experiencing and a growing number of assets in these vehicles that had gone beyond the investment period.

Often times they have either drawn and deployed all their limited partner commitments and were sitting on a lot of assets, trying to manage them through to a successful exit. Sometimes things don’t go according to plan, especially when you throw in a pullback in the capital market like we saw in the financial crisis.

They might have a portfolio of five or six assets and one of them is an underperformer, but the GP still believes that with more time and additional capital it could be quite a nice turnaround story.

If they did have access to that dry powder, they would be able to either enhance their NAV by pursuing more opportunistic transactions like executing on pre-emptive rights to inject new growth capital, facilitating acquisition capital in an underlying portfolio company or potentially buying out some of the co-investors at a discount.

They’re either protecting more value than the cost of our capital, or they’re buying more value with our money than the cost of our capital.

How did you decide upon the fund size?

We initially set out to raise $300 million. We increased that $500 million with a $600 million hard-cap after two years of executing this strategy through separately managed accounts and from our opportunistic fund.

It was all North American LPs; the biggest group of our investors were state and corporate pensions followed by endowments and then we had a couple of institutional wealth management platforms.

We’re targeting 12 percent to 15 percent gross return. That doesn’t necessarily mean that the underlying loans have that specific return profile, but on a portfolio basis we’ve been able to achieve that. It’s a shorter fund life, generally a six to seven-year term.

How is portfolio financing received in the market?

How you deal with the situations that are underperforming can ultimately decide how good of an overall fund you have. If a manager can do something to rectify a situation that’s always a good thing.

There is a stigma and it’s getting less so. A lot of managers now are looking for more opportunistic trades as opposed to just defensive trades, so adding value rather than just trying to preserve the value that they have.

It’s starting to get better documented in the limited partnership agreement. It should be accretive and all parties should be aligned if it’s the right use of capital.

Unfortunately if you go back to some of the older vintages and funds that are in harvest mode now, some of these weren’t fully dealt with. There’s some grey areas and we definitely need to make sure that everybody’s on the same page going into the trades.

It’s always better to have as many of the potential scenarios highlighted and clarified in an LPA and it takes going through various cycles for the managers, LPs and lawyers to really think through what some new potential scenarios are. All these different things tend to be better thought out now than 10 years ago.

Dave Philipp is co-head of fund liquidity solutions Crestline Investors. Prior to his appointment in 2013, Philipp served as co-founder of Crestline Kirchner Private equity Group, which provides succession capital for alternative investment funds. He also serves as a passive owner of global clean energy and sustainability investor Ambata Capital Partners.