In 2019, the provision of Net Asset Value (NAV) facilities to mid-end-of-life private equity funds that are well-invested or seeking additional liquidity gathered pace. Allowing for dividend recaps or additional bolt-on acquisitions to be made, banks and alternative lenders are increasingly overcoming their historic aversion to this form of financing, with new lenders appearing in the market. And with continued uncertainty slowing down the timing for potential investments, we can expect this trend to accelerate further in 2020.
The basic structure of the facility is to provide debt at, or just below, the fund level secured against the cashflows of all investments of a given fund. Although the lender’s security package is likely to be limited to share security and bank account security of holding vehicles above the portfolio companies, the lender does benefit from the diversification of different investments. This is different from a typical leveraged finance or acquisition facility that would normally provide the lender with security over the portfolio company’s asset without the benefit of recourse over the cashflows of other investments in the fund’s portfolio.
The key factor that will determine the future growth of these facilities will be the pricing that lenders are willing to make these facilities available for, which itself will be driven by how diversified and levered the investments are and what is the likelihood of a future exit of such investments.
There are a number of mid-market to upper-market PE funds that are carefully exploring this type of financing. If lenders can get comfortable with the fact that diversity can substantially lower their risk profile then these facilities could be used as a replacement for acquisition financing at the portfolio level. We know of at least one African-focused PE fund that uses such NAV facilities to make acquisitions of investments rather than getting portfolio leveraged finance and this model could expand as the number of lenders coming into this space grows.
One additional development in the funds finance market is the increased willingness of some lenders to lend against recall-able capital commitments of funds, which are provided by investors over and above the original capital commitments. It is quite common now for a fund to be able to draw down from investors more than such investors original capital commitments provided that such investors have received distributions. Typically, the amount of recall-able capital will be the amount of distributions investors have received capped out at a given maximum. As a fund approaches the end of its life the chances of increased recall-able capital becomes higher.
The increased appetite for lenders to provide both liquidity against NAV of private equity funds and recall-able capital means that funds will have much more facilities made available to them as they approach the end of their life cycle. This will continue to provide further growth in the funds finance market as the market for pure subscription-line financing becomes saturated and pricing of such facilities is driven down.
Leon Stephenson is a partner at Reed Smith LLP