Last month, the Institutional Limited Partners Association ("ILPA") weighed in on the interesting philosophical question that fund formation and finance lawyers frequently debate - what is a NAV loan? Where is the line between a fund-level borrowing on the one hand and a portfolio company borrowing on the other hand? Unsurprisingly, this line can be blurry, and ILPA's guidance suggests that if a fund-level or an SPV-level borrowing is secured by "all or substantially all" of the fund's assets, then that borrowing constitutes a NAV loan.1 This view highlights some potential ways to clarify a traditionally ill-defined concept.
As a starting point, the provisions of a fund's applicable governing document will govern whether a particular loan (NAV or otherwise) is permitted. In older fund documents, fund managers may have taken varying interpretations on the borrowing provisions contained in those documents depending in part on the level of comfort of the various players in their fund's ecosystem (investors, lenders, etc.). However, a renewed institutional investor focus on NAV loan provisions, alongside the new ILPA guidance, suggests managers may want to adopt more explicit provisions in their fund governing documents to avoid ambiguity and potential investor relations issues. Likewise, a fund manager should consider any applicable disclosures related to the use of fund finance facilities and any related risks.
To avoid ambiguity and other potential issues, managers may wish to affirmatively include language that (1) specifically allows fund level indebtedness beyond the more traditional provisions that have historically focused on subscription line financings secured by capital commitments, (2) specifically allows the use of subsidiary borrowers or special purpose vehicles in fund finance transactions (and any associated fund guarantees), (3) reflects any desired provisions regarding the level in a fund structure at which desired debt limitations are measured and (4) considers the impact of any time-based restrictions on any indebtedness (in other words, how long a loan can be outstanding). Particularly given the popularity of using leverage or even "back leverage" over a specific pool of fund assets, it is important for the legal documentation and expectations of all parties to be aligned.
ILPA's guidance may result in additional focus by investors on the borrowing provisions in fund governing documents and requests for additional restrictions and transparency, but it is clear that (1) NAV loans will continue to be a financing tool for funds and (2) the parameters applicable to NAV loans are likely to continue evolving in future fund documentation.
Footnote
1. See NAV-Based Facilities, Guidance for Limited Partners and General Partners, 2024, https://ilpa.org/resource/nav-based-facilities-guidance/, suggested definition for "NAV-based facility" – "means any borrowing or preferred equity financing at the Partnership level or at the level of any Borrowing Subsidiaries for the purpose of facilitating or funding Investments (including for follow-on investments), paying or reimbursing Partnership Expenses or other Partnership obligations or financing distributions to Limited Partners, which borrowing or financing is secured in whole or in part by all or substantially all of the fund's assets including equity Investments or distributions in respect thereof." (emphasis added).
"Borrowing Subsidiary" means one or more Persons or arrangements formed beneath or alongside the Partnership or an Alternative Investment Vehicle to facilitate the obtaining, administering or securing of, or primarily in connection with, obtaining a NAV-based facility or similar borrowing arrangement, including such Persons or arrangements formed to hold more than one Portfolio Companies for such purpose.
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