Crestline Investors on the ever-expanding NAV sandbox

This article is sponsored by Crestline Investors

Since the beginning of the pandemic, there has been a tremendous amount of media coverage highlighting the rapid growth of fund finance tools, especially NAV-based lending. Articles have reported on the increase in the number of borrowers alongside an expansion in the uses of capital, but often without details surrounding who is really using NAV loans or the innovative methods that are being implemented to deploy this capital.

As a leader in the non-bank lender space, with multiple funds and accounts looking for loan origination in the area, Crestline is at the forefront of many new ideas taking root across the industry, and we want to provide more transparency into what we are witnessing in the hopes it will inspire further creativity and adoption. In addition to overall market growth, we have seen four distinct trends emerge over the past three years.

Mid-market sponsors

We witnessed a significant increase in both the number and profile of traditional mid-market and lower mid-market buyout funds using NAV loans to secure capital and support their existing companies.

Initially, most of this capital was “down-streamed” as equity into underlying holdings to shore up balance sheets, fuel organic growth strategies or finance bolt-on acquisitions. An increase in awareness and adoption within this sponsor base allowed firms to further utilize NAV financing to proactively capitalize on liquidity-driven opportunities that arose from an anticipated increase in holding periods.

Commo transactions were either “buyout” trades, where a fund purchased the interests of minority shareholders in existing holdings, or “buyback” trades, where a sponsor repurchased LP interests back into the fund (akin to a treasury stock trade). Both transaction types added value to the fund by purchasing existing assets at a discount.

Real asset acceptance

We tracked an increased appetite from real estate and infrastructure firms tapping NAV lines for bridging purposes. The most common NAV uses we saw for real estate portfolios involved less traditional fund structures and often with developers that owned minority stakes in Joint Ventures (JVs) alongside larger institutional investors.

As holding periods for real estate extended during the pandemic, developers found themselves short of dry powder as they were unable to sell assets and recycle proceeds into future projects.

Rather than miss the opportunity to solidify their position in a new venture, and not wanting to syndicate out existing GP stakes (and the associated upside), they opted to borrow against their collection of minority positions in the JVs and use the loan proceeds to continue investing.

The developer then paid down the loan as existing projects were monetized in a more orderly timeframe. Infrastructure funds primarily used NAV lending as efficient bridge capital to progress greenfield and brownfield assets to completion.

Utilizing the high-quality collateral value of operating assets owned by the same fund to support a NAV loan, a sponsor was able to secure new capital at the fund level that could be invested to complete the last mile development of an asset. This capital was significantly cheaper and less dilutive than bringing in new third-party equity and was refinanced out with project financing once a project was operational.

“The latest onset of volatility has brought NAV lending back into the fold for sponsors and
investors alike”

Growth equity

We saw more growth funds come to the NAV party over the last three years. The most common transaction saw managers borrow new capital that allowed the fund to participate in a pre-IPO round (either to position the asset for monetization or capitalize on a structural uplift). The outsized nature of these pre-IPO rounds often outstripped a manager’s ability to capitalize on their full pre-emptive rights, and so proceeds from the NAV loan were used to participate fully.

Loan repayment came either from the IPO proceeds, from the sale of another asset, or new equity (from co-investors). As volatility increases, we expect to see more growth managers tap NAV facilities to selectively participate in down rounds and rescue financings.

Strategic fund management

Sponsors capitalized on activity in adjacent markets such as stake sales and continuation vehicles where they were able to manage their businesses in a more strategic way. We have worked with sponsors and advisers that were proceeding toward a stake sale but felt that the stake’s buyer was placing a steep discount rate on a near-term fund launch.

Instead of selling a stake prior to the launch of this new fund, the sponsor would borrow capital against holdings in prior funds to supersize a GP commitment in the upcoming fund, accelerate fundraising and reduce execution risk. The sponsor would then pursue the stake sale at an increased value and pay down the NAV line.

Regarding continuation funds, we found opportunities where a single asset, grouping of assets or entire portfolio were good candidates for a continuation fund, but needed some accretive growth capital in the short-term to improve the asset’s candidacy for a new vehicle. Injecting new capital designed to address portfolio concentration issues, enhance EBITDA plateaus or solidify fringe assets can add disproportionate value to investors by attracting a wider buyer universe and a better outcome for existing LPs.

Renewed market volatility is hampering the execution of many continuation vehicles, and we expect to see more bridging lines employed to support existing portfolios until the market environment normalizes. We are having discussions with a growing group of sponsors that want to explore shifting debt from individual portfolio companies up a level to the fund. The ability to manage a fund as something other than an “all-equity balance sheet” has appeal in various situations. There will be opportunities to gain flexibility and control without layering on any additional net debt in the system.

Re-assessing liquidity options

Recent events have once again reminded us of just how quickly sentiment, valuations and efficient access to markets can change. The latest onset of volatility has brought NAV lending back into the fold for sponsors and investors alike. Whether it is frozen secondaries markets resulting in unsuccessful processes or unwelcoming capital markets delaying exits, managers of private assets need to reassess liquidity options to weather the storm or capitalize on accretive opportunities stemming from the current market dislocation. It is clear that NAV lending, and fund finance overall, are becoming widely adopted tools, and the breadth of uses can facilitaste a sponsor’s ability to add value (offensively and defensively) in both up markets and down markets. We stand at the forefront of analyzing these trends, routinely engaging in discussions with prospective borrowers as they explore liquidity options through our products.

Dave Philipp is partner and senior portfolio manager, fund liquidity solutions, at Crestline Investors