How Should a Family Office Evaluate a Fund's Use of Borrowing?
Short answer. Evaluate debt by asking what it finances, who bears any loss, and whether the fund can make payments under adverse conditions. Review the debt documents and covenants. Check rate exposure and the refinancing plan. Then test returns and liquidity if income falls or costs rise. Consider what happens if financing becomes unavailable.
Debt can make a fund's results more sensitive to cash flow, asset values, and lender decisions. I trace borrowing through the full structure to see whether the fund can meet its obligations and preserve options if the plan weakens.
Trace Borrowing Through the Structure
Request a debt schedule for the fund and each borrowing entity. It should identify the borrower, lender, principal outstanding, rate, maturity, repayment terms, collateral, guarantees, undrawn facilities, and any other borrowing terms. Compare it with the fund's financial statements, offering documents, and organizational chart. Include debt at portfolio companies and related vehicles so the review covers the full structure.
Ask what the borrowed money finances and how the investment is expected to produce cash for repayment. Separate borrowing for a temporary timing need from borrowing that supports an investment with cash flows expected much later. If repayment depends on selling or refinancing an asset, ask for a fallback if that transaction is delayed or unavailable.
Test Debt Service Under Pressure
Review the sources of cash for interest and principal payments. Ask for the manager's base case and a downside case that reduces income, raises borrowing costs, delays a sale or completion, and lowers asset values where relevant. For a fund holding operating businesses, examine the effect of weaker revenue on cash distributions. For property, test lower occupancy or income alongside higher costs and financing expense.
Check how much covenant headroom remains in each case and when scheduled payments come due. An interest-only period can defer repayment without resolving it. Ask whether the model assumes a refinance, asset sale, or capital call to close a future cash gap, and whether distributions could be restricted. Reconcile those assumptions to the actual debt schedule and loan terms.
Understand Investor Exposure
Determine which entity bears a loss and whether a lender can reach assets outside the investment that borrowed. Ask if a shortfall could lead to a capital call, block distributions, force a sale, or reduce the value of another holding. Review the governing documents for authority to borrow or pledge assets. Check whether they allow requests for additional capital. Talk with your attorney about contractual obligations and your CPA about tax specifics.
Ask the manager: "Which entity owes each loan?" "What cash pays interest and principal?" "What happens if refinancing is unavailable?" "Can a lender reach assets outside the borrower?" "What would cause a capital call or distribution hold?" Compare the answers with the fund's debt schedule and documents. The borrowing terms that can put fund assets at risk cover collateral and lender remedies in more detail.
Record Assumptions and Warning Signs
Red flags include debt that cannot be reconciled across entities, vague answers about guarantees, little covenant room, or a repayment plan that rests on one optimistic exit. A projected return can look attractive while debt leaves less time to recover from a setback. Record the main assumptions and the first point at which payment capacity fails. Note what evidence would change the conclusion. The capital call and liquidity planner can help frame possible funding demands.
Checklist
- Reconcile debt schedules across the fund and related entities.
- Identify borrowers; record collateral, guarantees, rates, and maturities.
- Confirm the cash source for interest and principal.
- Stress test income and rates; include asset values and timing delays.
- Check covenant headroom and refinancing assumptions.
- Document possible effects on calls and distributions, including effects on other assets.
Go deeper: What assumptions in a property's forecast deserve independent validation?.
It's usually best to start with low leverage and then gear up to optimal capital structure once the business has shown that it can service the debt.
Sources: Family Office Club investor due diligence framework, Richard C. Wilson solo transcripts, The Single Family Office. Informational only, not financial, legal or tax advice.