NAV Financing as an Alternative to Secondaries, and How to Sell Your LP Stake

For a Limited Partner (LP) in a private equity fund, the need for liquidity can arise for a multitude of reasons.

A change in strategic asset allocation, a requirement to fund other commitments, or simply a desire to crystallise gains can all lead an LP to seek an early exit from their fund investment. The traditional path to liquidity has been the secondary market, where an LP can sell their fund interest to another investor. However, the secondary market is not without its challenges, and Net Asset Value (NAV) financing is increasingly being used as a sophisticated alternative.

The Secondary Market: A Double-Edged Sword

The secondary market provides a vital function in the private equity ecosystem, offering a mechanism for LPs to sell their illiquid fund interests. The process typically involves engaging a specialist secondary advisor who will run a competitive auction process to find a buyer for the LP’s stake. While this can be an effective way to achieve a full exit, it has several potential drawbacks.

Firstly, the process can be slow and cumbersome, often taking several months to complete. Secondly, the pricing can be uncertain and is highly dependent on the prevailing market conditions. In a buyer’s market, an LP may have to accept a significant discount to the Net Asset Value (NAV) of their interest to get a deal done. Finally, a secondary sale is a complete disposal of the asset. The LP gives up all future upside potential in the fund.

NAV Financing: A Flexible Alternative

NAV financing offers a compelling alternative for LPs who require liquidity but are not convinced that a full secondary sale is the right solution. A NAV loan allows an LP to borrow against the value of their fund interest, receiving an upfront cash payment without having to sell their stake. The loan is secured by the future distributions from the fund and is repaid over time as the fund makes distributions.

This approach has several key advantages over a secondary sale. Firstly, it is typically a much faster and more private process. Secondly, it allows the LP to retain their full ownership of the fund interest and to continue to benefit from any future upside in the portfolio. Thirdly, it can be a more tax-efficient way to raise capital, as a loan is not a taxable event.

An LP might choose a NAV loan over a secondary sale if they are fundamentally positive about the long-term prospects of the fund but have a short-term need for liquidity. It allows them to bridge a temporary funding gap without having to make an irreversible decision to sell.

How to Sell Your LP Stake

If an LP decides that a full exit is the right course of action, the process of selling their stake on the secondary market involves several key steps:

1. Portfolio Review and Valuation: The first step is to conduct a thorough review of the fund interest to be sold and to form a view on its likely valuation. This will involve analysing the underlying portfolio companies, the performance of the GP, and the current state of the secondary market.

   
   

2. Appoint an Advisor: For any significant secondary sale, it is advisable to appoint a specialist secondary advisor. They will have the market knowledge and relationships to run an effective sale process and to maximise the value of the stake.

   
   

3. Prepare Marketing Materials: The advisor will prepare a confidential information memorandum (CIM) and other marketing materials to present to potential buyers.

   
   

4. Run a Competitive Process: The advisor will approach a range of potential buyers, including specialist secondary funds, pension funds, and other institutional investors, to solicit bids for the stake.

   
   

5. Negotiate and Execute: The advisor will help the LP to negotiate the final terms of the sale and to execute the legal documentation to transfer the fund interest.

In conclusion, LPs seeking liquidity from their private equity investments have more options at their disposal than ever before. While the secondary market remains a viable route to a full exit, NAV financing offers a flexible and powerful alternative for those who wish to raise capital while retaining their long-term investment exposure. The choice between the two will depend on the specific circumstances and objectives of the individual LP.