NAV lending deserves a makeover – here’s why

In October 2023 the Financial Times wrote that “LPs worry that use of NAV…loans relies on financial engineering rather than underlying portfolio performance”.

LP concerns centre around debt being raised at the portfolio or management company level which increases risk, mostly indirectly, for LPs but with the benefits accruing to the manager.

Managers able to utilize NAV lending solutions are often able to return capital to investors sooner, albeit not via exits, and importantly, though seldom discussed, put an all important realised cash flow in the “distribution” column used in IRR calculations.

The importance of the latter is huge.

Imagine a $100 investment made on Jan 1st 2020. The difference between a single distribution of $200 on Jan 1st 2025, and five annual distributions of $40 is $0 on a “total value” basis, but a whopping 14% on an IRR basis (29% vs. 15%).

Amplified over multiple investments in a fund, and early return of capital could mean the difference between a fund being in the carry, or missing out.

So far, so in support of the FT.

We must remember though that similar concerns were raised in the late 2000s as the secondary market grew – GPs seeking to tidy up their LP base by coordinating secondary sales for inactive LPs, in some cases to attract fresh primary capital, were perceived negatively.

Despite this, today most perceive correctly that the growth of the secondary market has been highly beneficial for LPs – liquidity of LP stakes has increased dramatically over the past 20 years, and many see GP-led secondaries as part of the good housekeeping of asset management – in many cases such processes benefit those with trapped capital, and those seeking access.

Similarly with NAV lending, I believe the following solutions will develop over time, though in many cases these use cases aren’t yet here, or widely available: 

1. Distribution smoothing, benefitting LPs
2. Liquidity mechanisms
3. Tail end portfolio management
4. Deal warehousing 

1. Distribution smoothing, benefitting LPs

With re-ups and new investments by LPs driven in some cases by the return of capital from prior vintages, the ability of GPs to return capital may allow investors to avoid overexposure to managers who come back to raise successor funds. This point is effectively means better “cash utilization” for LPs.

2. Liquidity mechanisms

As well as providing capital for early distributions (rightly or wrongly), as private markets democratize and high net worth capital enters funds, it is likely that GPs both large and small will need to provide liquidity mechanisms for LPs, beyond organizing secondary processes. The ability of managers to raise debt capital, whether as a revolving facility or term loan, will improve the liquidity of private markets.

3. Tail end portfolio management

In 2010 many LPs expressed concern about “zombie funds” – final and often underperforming assets trapped in end-of-life funds without a viable mechanism for such investments to be exited. Secondary markets solutions have helped, but in many cases the enemy is the clock – GPs in sale processes often just need more time, rather than permanent liquidity.

4. Deal warehousing

Private markets have never fully solved the need for warehousing. The challenge has been that capital providers taken equity risk, for debt returns (with the risk being that they end up holding the investment instead of the borrowing sponsor). One of Ternion 's solutions to solve this is the Management Company Bridge Facility.

Whichever use cases emerge, it's clear that NAV lending is in its infancy. As with secondaries in the early 2010s, LP perception of the solution is improving, but slowly. In the meantime, perhaps it needs a makeover as a solution that benefits LPs as well as GPs.

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