Subscription Credit Facilities and Capital Calls

Introduction
Sometimes, in the hustle and bustle of private markets, GPs (General Partners) want immediate access to cash for a timely deal—and, well, waiting for LPs (Limited Partners) to wire over those much-needed funds just feels like an eternity. That’s where subscription credit facilities (often called “subscription lines”) step in. Picture these as short-term loans that a bank extends to a fund, using the LPs’ uncalled capital commitments as collateral security. If you’re thinking, “Isn’t that a neat trick?” then you’re not alone. Many GPs adore these facilities because they can close deals lightning-fast. But as always, no free lunch: interest costs, potential transparency issues, and liquidity risks for LPs are all part of the bargain. Let’s explore these dynamics in more depth.

Subscription Credit Facilities: A Quick Introduction
Subscription lines exist to solve a timing mismatch. You’ve got a great investment opportunity that needs funding right now, but your LPs typically require, say, a 10-to-15-day notice before sending capital. The solution? GPs draw on the subscription facility, close the deal without delay, and then call capital later to repay the facility. This can be a lifesaver in a competitive deal environment. As a quick analogy: Imagine you’re about to buy something on sale. You know the sale is fleeting, and you can’t wait two weeks to gather your own cash. Instead, you borrow on your credit card for the purchase, then pay it off once your paycheck arrives. Subscription lines serve a similar role but on a bigger scale.

Beyond speed and convenience, subscription facilities can create a positive effect—at least on paper—on the fund’s Internal Rate of Return (IRR). Since IRR calculations are highly sensitive to the timing of cash flows, delaying LP capital calls shrinks the visible holding period for investments. The result? IRR might look extra sparkly. But hey, just because the IRR looks higher doesn’t necessarily mean the underlying performance is any different. It’s a timing game.

How These Facilities Work
A typical subscription credit facility is negotiated by the GP with a lending institution—usually a well-known bank that understands private markets. The bank reviews the creditworthiness of the LP base, effectively evaluating the risk that LPs will meet their unfunded commitments. If the bank is comfortable, it grants a short-term revolving line of credit, typically up to a certain percentage (for example, 50–90%) of the total unsubscribed capital.

Then, whenever the GP needs quick money for an investment or to cover fund expenses, they draw from the facility. Eventually, the GP issues a capital call to the LPs, receives their capital contributions, and uses that money to pay down the loan. This process can repeat multiple times throughout the fund’s life—but there are borrowing limits and time frames to keep things from getting out of hand.

Below is a conceptual flow of how subscription credit facilities interact with capital calls and ultimate investments:

    flowchart LR
	    A["Limited Partners (LPs) <br/> Provide capital commitments"] --> B["GP: Manages the fund"]
	    B --> C["Subscription Credit Facility (Bank) <br/> Provides short-term loan"]
	    C --> D["Investments <br/> Acquire portfolio assets"]
	    D --> E["Portfolio Gains <br/> Return capital to GP/LP (Eventually)"]

Collateral, Interest Rates, and Terms
One hallmark of subscription lines is the collateral provision. Instead of pledging the fund’s underlying company investments—like real estate or portfolio companies—the primary collateral is the unfunded capital commitments from LPs. Banks might look for strong, reputable LPs with high credit quality and a willingness (and obligation) to honor their commitment obligations.

Interest rates on subscription lines are typically pegged to a reference rate (for example, SOFR or LIBOR in prior years) plus a margin. They’re often lower than what you might expect if you were taking a loan backed by the actual fund assets. Why? Because the bank is relying on the combined creditworthiness of the entire LP base—a powerful security.

Still, interest adds up, and if a GP draws heavily or leaves a subscription facility outstanding for too long, those interest costs could eat into the fund’s returns. Additionally, lenders limit the length of time any draw can remain outstanding, often requiring repayment within a set number of days or months. This ensures the GP relies on the subscription facility for bridging short-term needs rather than using it as a quasi-permanent line of credit.

Impact on IRR Calculation
Let’s be real: IRR calculations can be a bit finicky. You only have to shift a few early cash flows by a couple of months, and your IRR chart can do a little happy dance, going up by several percentage points. In the private equity (PE) world, the timing of contributions and distributions significantly affects IRR. Delaying capital calls through a subscription line means that LP money is technically “at work” for a shorter period. As a result, the IRR formula—(roughly) net present value of cash flows—suggests a nicer number when the outflow is delayed.

Of course, this doesn’t necessarily reflect actual performance. If you look at the total multiple on invested capital (MOIC) or TVPI (Total Value to Paid-In), the difference might not be as pronounced. But IRR, which is time-based, is definitely impacted. Many sophisticated LPs—especially large institutional investors—are pushing for more transparency on the use of subscription lines so they can get a clear picture of the true investment timeline. Rather than simply trusting an IRR figure that’s been boosted by a well-managed subscription facility, they also look at metrics that incorporate the actual economic experience, such as an adjusted IRR that accounts for the time funds were truly committed.

When Overuse Can Obscure Returns
While subscription lines can be beneficial in moderation, overuse can conceal the real timing of cash outlays. For instance, if a GP systematically draws from the facility for almost every deal and waits a long time before calling capital from LPs, the IRR might look fantastic—right up until interest costs start piling up or the fund eventually has to repay large chunks of borrowings. It’s like a friend who keeps covering expenses with a credit card just to impress you with how stable their checking account balance remains. Eventually, that bill is going to come due, and you better hope there’s enough liquidity to cover it.

From an LP perspective, an artificially inflated IRR can obscure performance comparisons across different funds or different managers. If you’re an LP carefully selecting your next private equity manager, you might see sensational IRR numbers in historical performance but fail to notice that this IRR was flattered heavily by subscription line usage. Many LPs now request “with and without subscription line” calculations to help compare apples to apples.

Key Observations for LPs
Review the Terms: From interest rates to maximum borrowing periods, understanding the fine print of a subscription credit facility is crucial.
Pay Close Attention to Collateral and Repayment Triggers: If a bank can force a capital call to repay the loan under certain conditions, LPs need to be prepared for unexpected drawdowns.
Understand the Possible IRR Boost: Some GPs are transparent about how the subscription line usage impacts reported performance. Others are not. Always dig deeper to get a sense of real economic returns.
Consider Overcommitment Strategies: LPs commonly overcommit, assuming not all funds will call capital at once. But if subscription lines mask actual call timing, there’s a risk of overextending your available liquidity when multiple funds eventually issue calls simultaneously.
Pacing Strategy for Peace of Mind: Many LPs employ pacing strategies that spread commitments over multiple funds or vintages. They do this to manage liquidity exposures and maintain a stable portfolio allocation to private investments.

Managing Capital Calls
Subscription credit facilities run parallel to the broader concept of capital calls (also called drawdowns). Typically, a GP issues capital calls to the LPs with a notice period—maybe 10 to 15 days—so that investors can free up the necessary cash. The GP schedules capital calls based on the fund’s investment pipeline, fees, and unforeseen expenses. Over the life of the fund, the GP must plan carefully to avoid calling too little (and missing out on an investment that needs quick funding) or calling too much (leaving idle cash that can dilute returns).

When subscription lines enter the picture, the GP might use them to bridge short-term needs, effectively reducing the number of capital call notices each year. For many LPs, fewer calls can be a bit more convenient—nobody loves scrambling if the timing is off. But it’s essential for LPs to trust that the GP won’t abuse the line to hide the fund’s true liquidity needs, and that GPs will keep them in the loop about how the credit facility is being used and when calls will likely be triggered.

Potential Risks and Pitfalls
Liquidity Risk in Downturns: If a market downturn spooks lenders, raising or maintaining a subscription line can become costly—or the bank might reduce the borrowing base. If that happens, a big capital call could arrive abruptly, leaving LPs in a liquidity crunch.
Interest Rate Increases: Higher interest costs from unexpected rate hikes eat away at fund returns. The convenience can be very expensive if the GP doesn’t manage the timeline properly.
Collateral Calls: If for any reason the GP fails to repay the facility when due, the lender can force a capital call to recover the outstanding balance. That could mean you, as an LP, get a sudden “urgent” capital call, also known as a “bank step-in” scenario.
Reputational Damage: If a GP overuses subscription lines to artificially inflate IRR, or if they fail to keep LPs informed, it can harm a GP’s reputation, making it harder for them to raise new funds.

Best Practices
Pursue Transparent Reporting: GPs should disclose both an IRR that reflects subscription line usage and an IRR that models how performance would look if the facility had not been used at all.
Monitor Capacity and Duration: Know how much the subscription facility can draw and how long the GP intends to keep it open.
Align with Pacing Strategies: LPs typically juggle multiple fund commitments over several years. Ensuring that the GP’s use of subscription lines won’t disrupt your overall liquidity planning is key.
Limit Overuse: While bridging capital calls for a few weeks or months is reasonable, using a subscription line for extended periods may hinder you from seeing the fund’s true risk and return profile.
Regular Communication: GPs and LPs can hold periodic check-ins (perhaps quarterly or semi-annually) to discuss how the subscription line is being deployed, any changes in borrowing capacity, or relevant interest rate developments. That way, no one is caught off-guard.

A (Slightly) Personal Anecdote
You know, the very first time I stumbled into a scenario with subscription lines, I was an analyst reviewing a fund’s IRR track record. I almost did a double-take when I saw that the fund’s real capital call timeline and the IRR timeline seemed wildly out of sync. My initial assumptions about how the IRR was so high started unraveling: “Wait, these guys are calling capital only nine months after they purchased the first portfolio company?” Then I realized they’d just borrowed under a subscription line for the first investment, delaying the capital call. It was a classic eye-opener that taught me to watch out for subscription line usage in reported returns.

Real-World Example
Imagine a middle-market buyout fund with total investor commitments of $1 billion. The GP arranges a subscription credit facility of up to 25% of commitments—so, $250 million. Early in the fund’s life, the GP invests in a target company for $200 million. Rather than call $200 million from LPs, the GP draws down $200 million from the subscription facility immediately. Six weeks later, the GP issues a capital call for $100 million, which partially repays the facility. The GP calls in the remaining $100 million five weeks later. Because of this two-month delay in calling the entire $200 million, the IRR calculation will show early investments being funded by the facility rather than LP contributions—thus “shortening” the period that LP capital is outstanding. If an LP were comparing this fund’s IRR to a similar fund that calls capital on day one, the difference might be striking—yet the underlying economics (once the interest cost is netted out) might not be drastically different.

Importance for CFA Level III Candidates
For the CFA Level III exam, especially the Private Markets specialization, understanding subscription credit facilities has become increasingly critical. Expect scenario-based questions that challenge you to differentiate “perceived performance” (inflated IRR due to subscription lines) from “actual performance” or to weigh the pros and cons from both GP and LP vantage points. You might be asked to propose best practices for a hypothetical pension fund or to demonstrate how to adjust IRR calculations for subscription facility usage.

References and Additional Resources
• ILPA Guidelines on Subscription Lines of Credit: https://ilpa.org/
• Stowell, D. (2017). “Investment Banking: Institutions, Politics, and Law.” Elsevier.

Practical Exam Tips
• Be ready to recalculate IRR under different timing assumptions (“with” and “without” subscription lines).
• Build a quick scenario analysis for capital calls. If a question states the GP used a subscription line for six months, think about how that shifts cash flow timing.
• Watch out for trick questions about interest expense. Understand how it affects net returns.
• Use real-life metrics like TVPI, DPI (Distributions to Paid-In), and MOIC to cross-check IRR-based claims.

Test Your Knowledge: Subscription Credit Facilities and Capital Calls