The market for NAV fund line financing was worth more than $100 billion in 2022, but it has the potential to exceed $700 billion by the end of the decade, according to 17Capital, a NAV financing provider.[1]
NAV financing—which has long been used by hedge funds[2]—is becoming increasingly popular with GPs managing private equity funds that are towards the end of their investment period, or midway through their lifecycle.
This form of financing allows GPs to borrow against the value of a fund’s assets, with the structure and terms of the facility arrangement based on the performance of the fund and the value of underlying investments. It is appealing to fund managers as it allows them to access flexible, non-dilutive capital while retaining full ownership of the underlying assets.
That ‘downwards-looking’ and asset-backed focus is in contrast to traditional subscription line financing, which is ‘upwards-looking’ and based on undrawn capital commitments from a fund’s investors. As such, the latter is particularly suitable for funds that are earlier in their life cycles, since the potential financing available to a fund shrinks once a significant amount of capital has been called, as in the case of those which are more mature.
Market Growth
The recent surge in NAV financing has been spurred in part by the Covid-19 pandemic. With many company exits temporarily paused due to market volatility, sponsors sought alternative sources of capital to manage their fund liquidity challenges. GPs soon realised that not only was NAV financing a smart way to manage liquidity constraints, but that it could also be used as a powerful mechanism to enhance returns.
For example, some GPs have been using NAV financing to fund new portfolio investments, such as accretive add-on acquisitions. Others might use it to bring forward exit proceeds, potentially allowing them to accelerate returns to investors. In addition, it can enable funds to hold on to their best assets for longer or help throw a lifeline to underperforming ones (on average private equity holding periods jumped to 5. 4 years in 2020 compared to 3.8 years a decade earlier[3]). It can also be used as a way to unlock lower-cost financing terms compared to pricier alternatives. And some GPs have used this financing to try to optimise overall fund performance and boost their internal rate of return (IRR). This is particularly beneficial to funds that have had a slower-than-expected capital deployment pace in their early years.
Lending appeal
NAV financing providers will typically carry out due diligence on the fund to assess its creditworthiness, with the credit limit usually set as a percentage of the fund’s net asset value. The loan-to-value (LTV) ratio on NAV financing deals is often between 20% and 30%, which makes it particularly attractive to lenders. The underlying assets will normally be used as collateral for the loans, though some established sponsors investing in certain high-quality assets might be able to access unsecured NAV financing. Funds repay the facility from cash flows generated by the underlying assets, with lenders given seniority over investor distributions until the loan is repaid.
NAV financing is proving compelling to lenders and investors who are seeking to gain exposure to the market, with a number of new funds emerging to take advantage of the trend. Last year, 17Capital closed its first NAV financing fund, raising €2.6 billion, while Ardian’s NAV financing platform has already deployed more than $3 billion to sponsors to support acquisitions or recapitalisations of secondary portfolios.[4] Whereas NAV financing was previously the preserve of mid-market sponsors, the growth in available funding means it is now more of an option for large-cap funds[5].
Collateral risks
Using NAV financing is not without risks to fund managers and investors. For instance, if the value of a fund’s assets falls or cash flows from the underlying portfolio companies slow down, the LTV ratio may increase to a point where the lender demands additional collateral. If the fund is unable to post more collateral or repay the loan, the fund’s assets may be at risk of being liquidated.
As market conditions remain uncertain however, sponsors and lenders are likely to continue fuelling further growth of the NAV financing market. For sponsors, it provides another avenue to obtain liquidity and an additional tool to manage fund performance prudently. At the same time, with both parties’ interests aligning, it offers lenders a potentially attractive risk-adjusted return. As participants begin to recognise the benefits of this mechanism more clearly, the appetite for NAV financing is unlikely to subside anytime soon.
Footnotes
1. The many use cases of NAV financing • 17Capital2. NAV Financing - What Was Old Is New Again - Lexology3. Fund finance: Harnessing NAV finance in new ways | White & Case LLP4. NAV Financing | Ardian5. NAV Financings: A Review of the Year | 02 | 2022 | Publications
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