Private credit investors seeking attractive, consistent returns might consider private credit funds that focus on lending directly to private equity firms, as opposed to their underlying portfolio companies. By investing in such funds, they finance the growth of private equity firms through credit instruments which are non-permanent and self-liquidating, resulting in a predictable cash flow profile with low volatility. The total enterprise value of private equity managers has been estimated at well over $500 billion, providing a deep addressable market for specialized financing providers in this space.
Dane Graham, Partner at 17Capital, highlights the benefits of this approach: “We specialize in net asset value (NAV) financing across the private equity ecosystem. One core area is providing financing to PE firms themselves, whether to their management companies or groups of senior partners, commonly referred to as ‘management company financing’ or ‘GP financing.’ These managers are seeking flexible, non-dilutive capital to build and expand their franchises or transition ownership to the next generation.”
PE firms generate cash flows from GP commitments (i.e., commitments to their own funds, alongside their limited partners), management fees, and carried interest. All or some of these cash flow streams can be utilized to service bespoke financing structures created by firms like 17Capital.
Use cases for management company financing
Management company financing allows PE firms to create investment capacity to address key growth initiatives across their businesses. “We offer non-dilutive, non-permanent financing for PE firms, principally to augment reinvestment in their funds and expand their overall platforms,” says Graham. “By doing so, the general partners have greater ‘skin in the game,’ which furthers their alignment with the fund’s limited partners and enhances potential returns for the manager.”
According to Graham, “As PE has matured, running a successful firm has become more capital-intensive. Managers are raising larger funds and committing more of their own capital – in many cases 5% or more of their total fund size, compared to 2%-3% in the past.” Graham also points to a liquidity gap in recent years due to the slowdown in realizations, which has made management company financing an attractive option for PE firms to maintain consistent pacing of new commitments.
Management company financing is also commonly used when PE managers seek to address ownership transition goals, including long-term succession planning. The motive for such financing is often a desire to enable the next generation to purchase a substantial ownership stake from original founders of the firm, repurchasing a portion of the firm’s equity from a passive outside shareholder, or simply providing some liquidity for the firm’s current leadership without compromising the fundamental economics of the business for the next generation.
By utilizing flexible financing solutions rather than selling equity, PE firms can address their capital needs while retaining long-term value internally, though managers of a certain scale will often employ multiple capital structure tools over time. “Everything we do is non-permanent and self-liquidating,” says Graham. “Management company financing doesn’t dilute ownership and can be repeated and modified as the firm’s needs evolve.”
Opportunities for private credit investors
Private credit firms, like 17Capital, raise capital from their own investors, who benefit from consistent, low-volatility returns provided by management company financing. Graham notes that investors who commit to these funds typically earn returns comparable to traditional mezzanine or opportunistic credit.
For providers of management company financing, the quality of borrowers, portfolio diversification, and the structure utilized are all important elements. “We focus on partnering with highly institutionalized PE franchises who manage well-performing funds with mature, profitable portfolio companies,” Graham explains.
Diversification across sectors, vintages, and assets is important to managing overall risk. Management company financings often benefit from exposure to multiple underlying funds of a particular PE firm, supporting resilience through economic cycles.
The seniority of the financing is a core feature, as the lenders’ accrued interest and principal is first in line for repayment when liquidity is generated through the various cash flow streams supporting the financing.
Graham offers a hypothetical example:
A private equity manager is seeking $250 million of management company financing for strategic growth initiatives, in this example to acquire a credit manager. The $250 million of financing is provided by a specialty financing provider who receives seniority over cash flows from the manager’s balance sheet commitments to its existing funds, with a total NAV of $500 million.
When liquidity is generated from the underlying funds and distributed to all investors, the portion attributable to the manager’s balance sheet commitments is first utilized to repay the financing, with remaining proceeds distributed to the manager once the financing is repaid. There is no impact to the manager’s underlying funds, or their respective external limited partners, and the manager retains full flexibility to manage the income and operating expenses of its own business.
Conclusion
The proposition of management company financing is compelling to private credit investors as a result of the senior status over cash flows, conservative attachment points, and high levels of underlying diversification. These tools offer PE firms an attractive, non-dilutive source of capital to finance their continued growth and ownership transition needs. Of critical importance, management company financing strengthens alignment between a PE firm and its own investors, supporting win-win outcomes for all stakeholders.