Private equity: capital call financing speeds up deals

Private equity tycoons are not patient people. They are often happy to pay more for convenience. When leveraged buyout firms assemble an acquisition or investment they request that their limited partners wire the required portion of capital pledged. That process can be time-consuming. Enter opportunistic banks.

Lenders are increasingly offering so-called capital call or subscription line financing. Here the private equity firm can borrow short-term (typically nine months or fewer) against limited partner equity commitments. The process can boost deal returns.

The financing makes life easier for private equity firms, whose trillions of dollars in dry powder led to a boom in financial engineering. Among the leaders in capital call lending is SVB Financial Group, formerly known as Silicon Valley Bank, which knows a thing or two about high-growth sectors. Of its $66bn loan book at the end of 2021, more than half was attributable to capital call lines of credit. In the past five years, SVB shares have more than doubled, well ahead of the S&P 500 and JPMorgan. SVB is forecasting that its loan portfolio will grow by 30 per cent this year, regardless of rising interest rates and a choppy economy.

With bridge financing available, the time between equity capital being called and an eventual exit shrinks. This means a deal’s equity rate of return will jump, even accounting for the interest cost of the short-term loan. Research from BlackRock shows that annualised returns rise on average by just half a percentage point. A good buyout fund will have an annualised return of greater than 20 per cent.

SVB describes capital call lending as “low credit risk” and claims that it has only suffered a single loss in three decades. That loss, however, was a gut punch. The bank took an $80mn charge after someone convinced both SVB and another institution to lend money to a fake private equity firm based on fabricated documents. The guilty party was eventually arrested and was recently sentenced to 97 months in jail. No form of lending can be totally risk-free, especially in high-growth markets.