A subscription credit line (also called a subscription facility, a capital call facility or simply a sub line) is a loan to a fund, secured by its investors' promise to fund capital calls. The lender doesn't look to the fund's portfolio companies for repayment. It looks to the LPs: if the fund doesn't repay, the lender can step in and call capital from them.
Sub lines are one of the most common forms of fund finance, and they touch almost everyone who works with private funds. Lenders size and monitor them. Fund finance and treasury teams draw and repay them. LP-side analysts need to know how much a fund uses its line, because it changes the fund's reported IRR. PE101 2.2 introduced capital calls and the subscription line; PC303 3.1 showed how credit funds use one. This lesson looks at the line from the lender's side and then works through its effect on returns.
How a subscription line works
Recall from PE101 2.2 that an LP's commitment is a binding promise to pay when the GP calls. The part not yet called is the uncalled (or unfunded) commitment. A sub line turns that promise into collateral.
The typical package has three parts:
- A pledge of the right to call capital. The fund grants the lender security over the GP's right to call capital from LPs and to enforce that right.
- A pledge of the account into which LPs pay their capital contributions.
- Rights to step in. If the fund defaults, the lender can issue capital calls itself and use the money to repay the loan.
In normal use, the fund draws on the line to make an investment or pay expenses, then calls capital from LPs weeks or months later and uses the money to repay the line. The line is revolving, so the fund can draw again. Most sub lines are short term, often a few years, and are commonly renewed or wound down as the fund's investment period ends.
The lender's real credit risk is the LPs, not the fund's investments. A sub line lender cares less about whether a buyout goes well and more about who the LPs are, whether the fund's documents clearly oblige them to pay calls, and whether any LP could refuse or be unable to pay.
The borrowing base
A lender won't lend against every dollar of uncalled commitments. Instead, it builds a borrowing base from the LPs it's willing to rely on, with a different advance rate for each group.
- Included investors are LPs the lender views as the strongest credits, such as rated institutions or large pension plans. They commonly get the highest advance rate.
- Designated investors are LPs the lender will count, but with less confidence, for example because they're unrated or the lender knows less about them. They get a lower advance rate.
- Excluded investors don't count toward the borrowing base at all. The fund can still call capital from them, but the lender gives no credit for it.
The fund can borrow the lesser of the borrowing base and the facility size (the commitment the lender has agreed to), less anything already drawn. That's the same logic as the asset-based borrowing base in lesson 3.1: the collateral sets one limit and the lender's commitment sets another.
The following example is illustrative. A fictional buyout fund has LPs with $800m of uncalled commitments. Its lender classifies them as follows:
| Investor group | Uncalled commitments | Advance rate | Borrowing base |
|---|---|---|---|
| Included investors | $600m | 90% | $540m |
| Designated investors | $200m | 65% | $130m |
| Total | $800m | $670m |
The borrowing base is $670m. But the facility size is $250m, so the fund can borrow $250m. As with Marrowgate Foods' asset-based loan in lesson 3.1, availability here is capped by the lender's commitment, not by the collateral.
That changes over time. Each capital call reduces uncalled commitments, which shrinks the borrowing base. Suppose that later in the fund's life, included investors have $200m uncalled and designated investors $50m. The borrowing base falls to $200m × 90% + $50m × 65% = $212.5m, which is now below the $250m facility size. At that point, the borrowing base is the limit.
Lenders also watch for events that remove an LP from the borrowing base, such as a credit downgrade, a transfer of its fund interest or a failure to fund a call. These are commonly called exclusion events. If exclusions push borrowings above the borrowing base, the fund usually has to repay the excess quickly, often by calling capital.
Why funds use them
GPs give several reasons for using a sub line:
- Speed. A fund can close an investment in days without waiting for a capital call notice period to run.
- Fewer, larger calls. Instead of calling LPs every time it funds a deal or pays a fee, the fund can batch calls, say quarterly. LPs' treasury teams often like the predictability. For a direct lending fund that funds many loans, delayed draws and revolvers (PC303 3.1), this can make operations much simpler.
- Bridging. A line can cover a gap, for example between signing and closing, or until a co-investor funds its share.
Lenders like sub lines too. They commonly see losses as unlikely because LPs' commitments are binding and the consequences of defaulting on a call are severe (PE101 2.2). That's one reason sub lines tend to be priced below loans to companies. But unlikely isn't impossible: the lender still depends on the fund's documents being clear and on LPs being able to pay in a stress.
The side effect: a higher IRR
A sub line delays when LPs' money goes into the fund. Because IRR measures return per unit of time (PE101 4.2), paying in later can raise the IRR even if the underlying investment is exactly the same.
The following example is illustrative. The same fictional buyout fund makes a $100m investment and sells it 3 years later for $150m.
Without a line. LPs pay in $100m at the start and get $150m back at the end of year 3.
- Multiple: $150m ÷ $100m = 1.50x
- IRR: 1.50^(1/3) − 1 = 14.47%
With a line. The fund draws $100m on its line to make the investment and calls capital from LPs a year later to repay it. The line charges 6% a year, so the first year's interest is $6m. To keep the arithmetic simple, assume that interest is paid out of the fund's proceeds, so LPs receive $150m − $6m = $144m. LPs now pay in $100m at the end of year 1 and get $144m back at the end of year 3.
- Multiple: $144m ÷ $100m = 1.44x
- IRR: 1.44^(1/2) − 1 = 20.00%
| Without the line | With the line | |
|---|---|---|
| LPs pay in | $100m at year 0 | $100m at year 1 |
| LPs receive | $150m at year 3 | $144m at year 3 |
| Years LPs' money is invested | 3 | 2 |
| Multiple | 1.50x | 1.44x |
| IRR | 14.47% | 20.00% |
The line produced a higher IRR from a lower multiple. LPs have $6m less profit, because they paid for a year of borrowing. But their money was invested for only two years instead of three, so the annual rate looks much better.
Neither number is wrong. They answer different questions. The multiple tells LPs how much money they made; the IRR tells them how fast. The issue is comparison. If one manager uses a line heavily and another doesn't, their IRRs aren't measuring the same thing. And if a fund's carried interest depends on an IRR-based preferred return, a line can help the GP reach that hurdle sooner.
Whether LPs are worse off depends on what they do with the cash in the year they keep it. If they can earn more than the line's cost elsewhere, delaying the call helps them. If the money just sits in cash, it doesn't.
What LPs and analysts look at
Because of this effect, LP-side analysts commonly ask about a fund's sub line:
- How long are draws outstanding? A line repaid within weeks barely changes IRR. One left outstanding for a year or more changes it a lot.
- How big is it relative to commitments? A larger line can delay more capital.
- Returns with and without the line. LPs commonly ask to see IRR both with the line and as if capital had been called when each investment was made.
- Multiples alongside IRR. Because the line lowers the multiple while raising IRR, looking at both (PE101 4.2) shows what's going on.
Key terms
- Subscription credit line: A loan to a fund secured by LPs' uncalled commitments and the right to call them.
- Uncalled commitment: The part of an LP's commitment the GP can still call.
- Included investor: An LP the lender counts in the borrowing base at the highest advance rate.
- Designated investor: An LP the lender counts at a lower advance rate.
- Borrowing base: The sum of each counted LP group's uncalled commitments multiplied by its advance rate.
- Facility size: The maximum the lender has agreed to lend, whatever the borrowing base.
- Exclusion event: An event, such as a downgrade or a missed call, that removes an LP from the borrowing base.
Key takeaways
- A sub line lender relies on LPs' binding commitments, not on the fund's investments.
- The borrowing base weights LPs by quality: $600m × 90% + $200m × 65% = $670m, but a $250m facility size caps borrowing at $250m.
- As capital is called, the borrowing base shrinks and can become the limit.
- Delaying calls can raise IRR while lowering the multiple: 1.50x and 14.47% without the line, 1.44x and 20.00% with it.
- LP-side analysts compare returns with and without the line and look at IRR and multiples together.
This lesson is for educational purposes only and is not investment advice.