NAV Lending Ramps in Popularity, but Questions Remain
In a muted exit environment, some firms have taken on NAV loans to bring additional capital to long-held portfolio companies. The LP community is split on the benefits or pitfalls of the strategy
NAV lending seemed to burst on the investment scene as “the popular new kid on the block” this year, with many stories written about its usage, firms coming out with new funds and lawyers debating its merits. Except it’s not exactly new: many firms have been offering the product for years, but they say awareness and acceptance of the strategy has grown among GPs and LPs. The strategy, which involves lending money to a private equity fund at a late stage in a fund’s lifecycle to use for additional investment needs is based on the “net asset value” of the remaining assets in the PE fund.
Experts say private equity funds can use these loans as a lifeline when the remaining assets in the portfolio need more capital and aren’t ready to be sold, but most of the LP money has been drawn down already.
In a tough market environment like the one we’ve seen in the last few years, where exits are light and companies might need more runway before an exit, firms have been using NAV loans, continuation funds and other strategies to extend the lifecycle of their holdings.
Firms that offer NAV loans say they’ve seen growth in interest. 17Capital, which was founded in 2008, has seen deal flow activity growing at 30-50% annually in recent years, with record volume of over $35 billion during the first nine months of 2023, according to managing director Greg Hardiman.
Pros and Cons
Most clients using NAV facilities at the fund level are tapping them to finance add-on acquisitions at portfolio companies, Hardiman says. “Activity has been highest for fund-level NAV loans and there are a number of drivers for this. One is simply market awareness. It really started to accelerate a few years ago during COVID with private equity firms needing to have an understanding of the full spectrum of available liquidity options,” he says. “That awareness converted into robust activity from late 2020 through today, both for 17Capital and other firms addressing this market.”
17Capital operates primarily from London and New York, and has been providing NAV financing in North America since its founding. Other European firms have recently stepped into the NAV lending game, with Pemberton and AXA Investment Managers launching dedicated funds for NAV lending, according to media reports. People familiar with the strategy say other U.S. firms have been forming dedicated funds in the space on this side of the Atlantic, too.
Some proponents of the strategy say NAV loans can be beneficial to LPs by freeing up some capital to return money to investors and getting portfolio companies readier for exits. The strategy has also drawn some criticism from the investor community, according to Institutional Investor and other publications. Some LPs and their advisors see NAV loans as “adding leverage on top of leverage,” according to an Institutional Investor article on the trend published in August.
When it comes to NAV loans and continuation funds, some LPs worry they could be used to prop up struggling businesses that will eventually fail and have even more debt.
NAV financing can be structured in the form of a NAV loan or preferred equity instrument, with the NAV lender ahead of an LP when it’s time to return money to investors. 17Capital has deployed $7.4 billion through preferred equity and 82 investments, and $4 billion through NAV loans and 14 investments, according to its website.
There is a diversity of perspectives on NAV financing in the LP community. In many cases, it provides an important source of liquidity when there is a lack of exits and distributions.
Lawyers and NAV fund managers say structuring the agreement as preferred equity could be easier for the GP as they often have more limitations on any debt the fund can take on. “LP Agreements are very limited in terms of fund-level debt facilities, so there are industry discussions on how it can take place,” says Matthew Kerfoot, partner at law firm Proskauer. Regardless of the structure, a private equity fund looking to take on NAV financing will usually have to get consents from LPs in the fund or have an existing provision in the LPA (limited partner agreement) that allows for these loans to begin with. “There is a diversity of perspectives on NAV financing in the LP community. In many cases, it provides an important source of liquidity when there is a lack of exits and distributions,” says Kerfoot.
His firm is working on several NAV lending deals “to provide additional capital to use for portfolio companies where an exit isn’t feasible for the next 12 months.” He says there has been more education and acceptance in the LP community on NAV loans and sponsors are usually transparent with LPs on the use of proceeds.
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Both he and Hardiman say some of the largest well-known private equity firms have been taking on NAV loans, which gives the product enhanced confidence. “If they think it’s a good idea, others might think it’s a good idea,” says Kerfoot. Hardiman says the firm prefers to work with larger private equity firms that have long track records of strong performance, which gives people more comfort in the strategy.
Hardiman says the loans are usually priced like senior or unitranche debt facilities, with an 400-800 bps spread over base rate. Maturities range from three to five years, according to Kerfoot.
When it comes to working with LPs, 17Capital also offers NAV financing to institutional investors. “LPs are facing a slowdown in realizations, yet they’re in an environment where the coming PE vintage could be very attractive and they don’t want to be on the sidelines. As such, there has been greater interest in NAV financing from LPs compared to the prior several years,” says Hardiman.
In this scenario, an LP “would take their commitments to private equity and work with 17Capital on a preferred equity interest in their portfolio to help them fund capital calls and make new investments,” Hardiman says. “The way I’d characterize it is: preferred equity is a higher cost but more flexible type of NAV financing.”
Regardless of whether NAV financing is explicitly allowed in LPAs, “there is a dialogue between LPs and GPs on the opportunities in the portfolio, what the funding options are, and ensuring that there is buy-in to execute a NAV facility. The GP is not going to go forward with a NAV loan if the LPs are not on board,” Hardiman says.
Anastasia Donde is Middle Market Growth’s senior editor.
Middle Market Growth is produced by the Association for Corporate Growth. To learn more about the organization and how to become a member, visit www.acg.org.