As the use of NAV financing in private capital structures becomes increasingly prevalent, it continues to come under greater scrutiny from the media, regulators (such as the Bank of England) and investors (LPs).
The latest contribution to this public discussion comes from the Institutional Limited Partners Association (ILPA), the influential lobbying body that seeks to advance LPs interests. At the end of July 2024, ILPA issued guidance:
i. addressing the use of NAV financing in private equity strategies (the guidance expressly does not address its use in other strategies, such as private credit); and
ii. suggesting means for improved transparency and dialogue between LPs and those sponsors (GPs) looking to use NAV financing.
The guidance makes six key recommendations.
- If a fund limited partnership agreement (LPA) is silent about NAV financing, a GP should seek the consent of the LP advisory committee (LPAC) before putting any NAV financing in place.
- Even if an LPA expressly authorises the use of NAV financing, the GP should seek LPAC approval if it will be used to fund distributions to LPs.
- Conflicts of interest associated with a NAV financing should be taken to the LPAC.
- For future fundraisings, LPAs should expressly establish the parameters for the use of NAV financings.
- For existing funds with LPAs that are silent about NAV financing, LPs should proactively engage with GPs to see whether they have interpreted those LPAs as permitting NAV financing below the fund and, if so, whether that financing has been included or excluded from the LPA restrictions on fund-level borrowings.
- A GP that puts a NAV financing in place should provide LPs with standardised disclosures about the financing.
Commentary
The recommendations relating to conflicts of interest and transparency are not surprising. They reflect what we see in the market already: GPs tend to be happy to discuss prospective NAV financings with LPs and/or LPACs. Similarly, as NAV financing continues to be a trending topic in the fund finance sector, LPs are increasingly alive to their use in private equity strategies and are eager to understand the associated risks and impacts as part of their investment diligence processes. As the ILPA guidance itself notes, some larger LPs are themselves keen to participate in NAV financing arrangements for the funds in which they have a primary investment.
The recommendations dealing with the interpretation of LPAs are perhaps more notable. It remains relatively rare for private equity fund LPAs to give GPs an express power to enter into NAV financings; instead, it is common for LPAs to:
- grant GPs broad borrowing powers at both fund- and SPV-level that, intentionally, do not prohibit NAV financings at SPV-level; and
- disapply fund-level borrowing restrictions to those financings, so long as they have no "upward" recourse to the fund and its undrawn commitments.
In our experience, most GPs currently fundraising are resisting requests that any future NAV financings be subject to LP or LPAC consent. It will be interesting to see though how this point develops, and whether NAV finance providers start to push for LPAs to address NAV financings explicitly.
As with other ILPA guidance, it is worth noting that it is not intended to be universally appropriate or applicable in every instance. GPs should nevertheless be aware of the guidance and the likelihood that LPs will refer to it in NAV financing-related discussions and general due diligence processes.
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