LP acceptance of NAV financing is critical to the market’s longevity and growth. That acceptance will only be built on a base of communication and trust. “In the early days of this industry, a lot of transactions were solving problems that weren’t of the LPs making, such as a weak fundraising. In many cases, that financing had a negative impact on LPs and so, in some instances, investors have come to see NAV financing negatively,” says Thomas Doyle, partner and head of NAV financing at Pemberton. “In the past, some GPs also raised NAV financing to solve poor performance, artificially creating liquidity to drive IRRs and DPI. Again, this was self-serving, and LPs have grown wise to such uses.”
Pemberton strongly believes that a healthy interaction with LPs is critical and is heavily focused on educating LPs about the questions they should be asking, as well as educating GPs about what they should be disclosing. “Without that healthy dialogue, LPs will remain suspicious that the GP is trying to carry out financial engineering at their expense, which is often not the case,” says Doyle, who cites the example of a portfolio of 10 companies where one or two are underperforming, as a case in point.
“Historically, those companies that are fundamentally strong but were having cashflow issues would have gone to the wall. Now, you can raise capital against the overall portfolio and use the proceeds to strengthen those weaker-performing companies. Instead of them failing during difficult times, they can live through that period of stress and ultimately bring returns for the LPs. There is clear alignment of interest between GP and LP in situations like that.”
Dave Philipp, partner at Crestline Investors, meanwhile, says the LP education process is well underway. “LPs are asking their managers better questions around use of proceeds, expected value uplift, expected duration of the loan, and what the upsides and downsides of proposed transactions are.”
17Capital’s head of investor relations and fundraising, Drew Fox, says: “It is an adoption curve that we have seen in many areas including subscription finance, GP-led secondaries and the sale of minority stakes in GPs. When these new technologies are in the early stages, there is little familiarity and understanding and a relatively high degree of skepticism among LPs.
“NAV finance is following a similar trajectory. As more sponsors utilize NAV finance, more LPs are becoming aware of its existence and understanding that these tools are helping sponsors manage their portfolios, manage holds, manage exits and thus ultimately generate higher returns for their investors.”
“In some instances, investors have come to see NAV financing negatively”
Regardless of whether LPs are accepting of the rationale for employing NAV finance, fund documentation still often precludes the use of leverage at the fund level, creating structuring complexities. “In many circumstances, whether or not it is required under the fund documents, sponsors choose to speak with LPs to clear the incurrence of a NAV facility in order to maintain good relationships,” says Debevoise & Plimpton partner Pierre Maugüé.
Jamie Mehmood, partner and head of fund finance advisory at Deloitte, says that, anecdotally, explicit mention of NAV financing is creeping into recent LPAs. “I think this gives you a sense of the direction of travel.”