A more established staple in the European fund finance market, U.S. lenders have seen increasing demand from closed-end private equity, venture capital, and other investment fund borrowers (“Funds”) for net asset value (“NAV”) credit facilities. Historically, subscription credit facilities (“SCFs”) (i.e., revolving credit arrangements that “look up” for security to the contractual obligations of investors to fund their undrawn capital commitments) have dominated the fund finance market in the U.S.; however, in recent years there has been substantial growth in the demand for NAV financing both in the U.S. and abroad. Empirical data on NAV financing is scarce, but the rise in demand for this relatively nascent and esoteric product can be anecdotally traced to the COVID-19 pandemic. During that time, macroeconomic uncertainty contributed to the reticence of sponsors to call capital from limited partners, leading Fund sponsors to seek additional liquidity for portfolio companies.
Unlike SCFs, NAV financings are secured not by investors’ undrawn capital commitments, but rather “look down” for recourse against the underlying portfolio investments of a Fund. As a result, the product has become an increasingly attractive source of liquidity for end-of-life or near end-of-life Funds that have called and deployed all or a significant portion of their investors’ capital commitments. Historically, NAV facilities have been limited to credit, secondaries and infrastructure funds operating with existing leverage strategies. A more recent development in the NAV financing space has seen an array of sponsors using NAV facilities to add an additional layer of Fund-level leverage in connection with or immediately following a strategic portfolio company acquisition. Thus, in addition to borrowing at the portfolio company level, the sponsor employs a NAV facility to back-lever the acquisition financing. While a back-levered NAV facility has no direct credit support from the portfolio company, it allows the sponsor to finance a portion of their equity contribution in the acquired portfolio company, which increases the overall leverage of the underlying transaction by adding an additional layer of fund-level leverage.
The structure of back-levered NAV facilities has come to bear resemblance to margin loan structures. However, margin loans alone—which rely on daily mark-to-market pricing of liquid securities to maintain compliance with loan-to-value (“LTV”) covenants—are intrinsically incongruous for Funds seeking liquidity in the form of privately held single-asset back-levered transactions. As a result, back-levered NAV facilities are necessarily bespoke and require lenders to closely examine, among other considerations, transfer restrictions in the underlying portfolio company’s governing documents, including rights of first refusal, pre-emptive rights, tag-alongs and drag-alongs, in addition to obtaining consents from the issuer and any required shareholders to waive transfer restrictions that would otherwise arise in a foreclosure scenario.
In summary, the appetite of sponsors for single-asset financing via back-levered NAV facilities remains to be seen in the shifting macroeconomic and political environment we are currently experiencing; however, it is clear that the use of NAV financings as a reliable leverage option for Funds is likely here to stay notwithstanding current market uncertainty.