NAV Loans: Facts Versus Fiction

NAV lending is one of the fastest growing corners of private markets, yet it remains one of the least understood. Many fund managers, family offices and limited partners have never used a NAV loan, and much of what they have heard comes from a handful of headline deals rather than from how the product is used day to day.

This article sets out six of the most common misconceptions about NAV loans and what the market actually shows.

What is a NAV loan?

A NAV loan is a loan made to a private fund or investment vehicle and underwritten against the net asset value of its portfolio. The lender looks to the value of the underlying investments, and the cash they generate, for repayment. It does not rely on investors' unfunded commitments.

NAV loans sit within the wider fund finance market, which is estimated at around $1.5 trillion. Subscription lines, which lend against investors' undrawn commitments early in a fund's life, make up roughly three quarters of that market. NAV facilities are a much smaller share, but they are growing quickly as funds mature and hold portfolios of assets with real value but limited liquidity.

It helps to separate three products:

• Subscription lines lend against unfunded investor commitments and are typically used in the early years of a closed-end fund.

• Hybrid facilities combine a subscription line with additional support from the portfolio's NAV.

• Pure NAV facilities lend only against the value of the portfolio, with no recourse to investor commitments.

A NAV loan is also distinct from a GP or management company facility, which lends against carried interest or fee income. A NAV loan concerns the fund and its investments only.

Fiction 1: A NAV loan means the fund is in trouble

Fact: NAV loans are as often offensive as defensive.

The most common use of a NAV loan is to back a strong portfolio company, not to rescue a weak one. A typical case: a buyout manager has raised a $1 billion fund and invested $900 million of it. One portfolio company has the chance to make a material add-on acquisition, but cannot finance it with more debt at company level. The manager needs fund-level capital, quickly, without calling on investors who may already be fully drawn.

A NAV loan solves that problem efficiently. The return a sponsor targets on a dollar of equity is often 20% to 25%. An all-in NAV loan cost might be in the region of 7% to 11%. Using the cheaper capital where it is appropriate can improve both IRR and the multiple on invested capital for GPs and LPs alike.

Some of the largest buyout sponsors now put a NAV facility in place at the start of every fund as a standard part of their toolkit, precisely because it gives them certainty of extra dry powder when an opportunity appears.

Fiction 2: NAV loans are basically debt-funded distributions

Fact: Distributions are a small minority of use cases, typically around 5%.

Using NAV loan proceeds to return cash to LPs attracts most of the press coverage, and it is the use case that deserves the most scrutiny. But it is rare. Industry surveys and lenders' own books consistently put it in the single digits.

Most NAV loans fund follow-on investment into existing portfolio companies. Surveys put that share at around half of all facilities, and some lenders report it is closer to three quarters of what they see. Other common uses include:

• Continuation vehicles, where a NAV facility can bridge a delayed funding of new capital, or provide liquidity to a vehicle that has already called its equity.

• Supporting a single asset through a difficult period, as an alternative to raising fresh equity from investors.

• Portfolio management across buyout, credit, secondaries and multi-asset vehicles, wherever there is a pool of illiquid assets with a measurable value.

Fiction 3: Fund-level debt is automatically highly levered

Fact: NAV loans are conservatively underwritten, and actual leverage is usually low.

Loan to value (LTV) is the key measure. Typical limits are:

Those figures are usually the maximum a borrower can draw up to. In practice, the amount drawn at closing is often lower, in the region of 10% to 15% on average. Conventional private equity NAV facilities rarely exceed 20% LTV.

Lenders add further protection through:

• Concentration limits, so that no single asset counts for more than around 30% to 35% of the borrowing base.

• Eligibility criteria, under which an asset marked below roughly half of its cost, or one that suffers a debt acceleration or insolvency event, can drop out of the borrowing base.

• Cash sweeps that increase as LTV rises or diversification falls, so the loan deleverages as stress builds.

Fiction 4: If the LPA does not prohibit it, there is little to worry about

Fact: Governance still matters, and transparency with LPs is best practice.

Many older limited partnership agreements say nothing specific about NAV facilities, because the product was not widely used when they were drafted. Silence is not the same as consent.

The Institutional Limited Partners Association (ILPA) has published guidance on NAV facilities that calls for clear disclosure of the facility, its purpose and its terms. In practice, good managers now:

• Discuss the facility with the LP advisory committee (LPAC) before signing, and seek LPAC approval where the LPA is silent.

• Disclose the size, use of proceeds, LTV, covenants and the alternatives considered.

• Review side letters for restrictions on borrowing or pledging assets.

• Address any conflicts of interest and keep the arrangement at arm's length.

• Report on the facility's performance and any refinancing over time.

LPs are business people. When a manager lays out the case clearly, the response is usually constructive. Problems arise when a facility is put in place without explanation, and LPs remember that when the next fund comes round.

Fiction 5: NAV loans are expensive

Fact: Pricing has compressed, and NAV loans are often cheaper than the alternatives.

Margins for NAV facilities typically fall in a range of around 3% to 7% over the base rate, with upfront fees of roughly 1% to 1.5%. Where a facility can be rated investment grade, pricing can be at the lower end, because insurance capital is an active and growing source of funding in the market.

Pricing depends mainly on two factors: LTV and portfolio diversification. A low-LTV loan against a broad portfolio will price well inside a concentrated, higher-LTV deal.

Compared with the realistic alternatives, such as HoldCo PIK notes, preferred equity or co-investment equity, a NAV loan is frequently the cheaper and faster route to capital.

Fiction 6: The lender will interfere with portfolio companies

Fact: In a recourse-light structure, the lender controls cash flows, not companies.

Most NAV loans today are made to a newly formed special purpose vehicle (SPV) that sits below the main fund and holds the assets in the borrowing base. Many use a recourse-light structure, in which the lender receives:

• A pledge of the economic rights to distributions from the investments.

• Control over the bank account into which those distributions flow.

• Payment direction letters instructing portfolio companies to pay distributions into that account.

The lender does not take an equity pledge over the companies and does not vote. If a covenant is breached, the lender's remedy is to sweep cash until the loan is repaid or back within its limits. It is not to force a sale of portfolio companies at the bottom of the market.

That patience is a real protection for GPs and LPs, and it is one reason documented defaults in NAV lending are rare.

The bottom line

NAV loans are a mainstream tool for managing illiquid portfolios. They are mostly used to back good investments, they are conservatively levered, they are competitively priced, and in most structures the lender has no say in how portfolio companies are run.

The misconceptions persist largely because the product is newer than subscription lines and less widely discussed. Subscription lines faced the same scepticism when they first appeared and are now routine. NAV lending is on the same path.

Frequently asked questions

What is a typical LTV for a NAV loan?

Diversified buyout portfolios typically borrow up to 20% to 30% LTV, while venture portfolios are usually limited to 5% to 10%. The amount actually drawn at closing is often lower, around 10% to 15% on average.

What are NAV loans mainly used for?

Most NAV loans fund follow-on investments and add-on acquisitions in existing portfolio companies. Funding distributions to LPs accounts for only around 5% of use cases.

How much does a NAV loan cost?

Margins typically range from around 3% to 7% over the base rate, with upfront fees of about 1% to 1.5%. Pricing depends mainly on LTV and how diversified the portfolio is.

Can a NAV lender take control of portfolio companies?

Not in a recourse-light structure. The lender has rights over distributions and the account they are paid into, and can sweep cash if covenants are breached, but it does not hold voting control over portfolio companies.

How long does it take to arrange a NAV loan?

Timelines vary with the complexity of the portfolio and the borrower's experience, but four to eight weeks from mandate to closing is common.