What are NAV facilities?
Net asset value financing – so-called “NAV facilities” – are credit facilities secured by the equity value of a fund’s investment portfolio. Unlike subscription line financing where the credit decision is made by the lenders based on the value of investors’ undrawn commitments in the fund (so-called upward looking financing), NAV facilities allow funds to borrow based on the value of their portfolio investments (“downward looking financing”), providing them with efficient and flexible access to additional capital.
NAV facilities typically take the form of a term or revolving loan facility granted by lenders to a fund or a special purpose vehicle (SPV) of a fund. The collateral package would typically be tailored to the transaction and would generally depend on an array of factors (including the fund’s strategy and type of investments, the location of the borrowing vehicle in the structure, as well as regulatory and tax considerations). Such package would usually include a pledge over the equity interests in the SPV(s) and/or or portfolio companies, a pledge over the bank account(s) into which portfolio investment distributions or payments are to be received by the Fund and/or the SPV, and/or a security interest over the distribution claims/receivables owed by the portfolio investments. Given the maturity of the market, there is no one-size-fits-all in terms of what a typical NAV deal looks like.
NAV facilities can serve a variety of purposes, from addressing liquidity constraints to driving value creation. They are particularly relevant for late-stage funds with few undrawn commitments left or funds confronted with a liquidity shortage.
Given the maturity of the market, there is no one-size-fits-all in terms of what a typical NAV deal looks like.
Why are NAV facilities on an upward trend?
The increasing popularity of the NAV facilities is due both to the variety of purposes NAV facilities can serve and to the current market environment.
Funds make use of NAV facilities for working capital purposes, to boost return and to fund distributions to investors, to inject additional capital for their “follow-on” investments and to provide liquidity to portfolio companies facing distress. In capitalising on the value of their investment, sponsors have an easy access to a financially attractive loan. Indeed, NAV financing backed by the fund’s entire portfolio comes at a lower cost than individual portfolio company financing.
Additionally, the greater use of such tool to counter the slump of distributions in the private equity (PE) sphere is notable. In the current somewhat challenging economic environment characterised by high interest rates and weaker economic outlook, many funds struggle with finding profitable exit opportunities for their portfolio companies, with buyers and sellers being at odds over valuations. The resulting liquidity bottleneck has put fund managers under pressure to accelerate distributions to their LPs, especially where the LPs themselves are obliged to make payouts to their beneficiaries (as is the case with pension funds). To solve this problem, certain investment funds have sought recourse in NAV facilities using them to monetise returns, drive up IRRs but also to avoid rushed exits in the hope that retaining portfolio assets for a longer period of time would allow them maximise the upside potential and delay the divestment until market conditions improve.
What does the future hold for NAV facilities?
The NAV financing space currently represents around EUR 100 billion and is projected by certain players to triple in size by 2025.
The increasing use of NAV facilities has recently brought a higher scrutiny from LPs. It is advisable for the managers to ensure that the purposes, costs and risks of the NAV financing are properly communicated to, and if necessary discussed with, the LPs. In May 2024, the Institutional Limited Partners Association (ILPA) is set to release guidance aimed at enhancing LP education, as well as transparency regarding the use of NAV financing. Although funds’ LPAs typically already include detailed provisions related to subscription line financing, the ILPA will now provide guidance on incorporating also NAV facilities provisions into the LPAs. If the fund LPA should indeed allow for the use of NAV financing, it is crucial to consider the wider context of investor relations and commercial aspects. We expect that the NAV facilities market will evolve towards greater transparency, as LPs will be keen to understand how the proceeds of the NAV facilities are deployed and the costs and risks related to it.
Regardless of the above, the NAV financing space currently represents around EUR 100 billion and is projected by certain players to triple in size by 2025. In the next years, many sponsors are expected to make use of such tool for multiple purposes (some of which may still be undiscovered). We anticipate that this financing segment is likely to continue its expansion.
Finally, the success of NAV facilities has created lending opportunities and more lenders are entering this market. We foresee that private credit funds lending to other funds will increasingly look at NAV facilities as portfolio investments noting their potential of attractive risk adjusted return.