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Sponsored by Arcmont Asset Management
NAV Financing and GP/LP Solutions: supercharging value creation with flexible financial technology
by Peter Hutton, Head of NAV Financing at Arcmont Asset Management
NAV loans are not new, but the adoption rate by sponsors is growing rapidly. What’s all the fuss about?
In the last two decades, the market has undergone a structural shift with sponsors demanding increasing flexibility and financing optionality.
In the early 2000s subscription lines began to play a valuable role in reducing the administrative burden for GPs whilst smoothing out LPs’ capital calls. After the Global Financial Crisis, Direct Lending emerged to fill the void left by banks. More recently, the rise of Continuation Funds has enabled sponsors to hold onto their star-performing assets for longer. And now NAV Financing is the latest example of this structural shift, as a development in flexible financial technology offering sponsors additional firepower to bolster their M&A capabilities and enhance equity value for LPs (see chart 1).
Chart 1: NAV is mainly used for M&A
NAV financing use of proceeds
1 ILPA Guidance on NAV Facilities 2024.
2 Proskauer (Insights of the NAV Lending Market, Full Year 2023)
Adoption of NAV Financing in Europe has grown from <5% ten years ago to c.35% today. The most significant driver of demand for NAV Financing is to generate additional firepower to drive portfolio company growth through additional M&A — often after the end of a Fund’s mandated investment period. As is often the case, necessity has been the mother of invention. According to Bain and Company, multiple expansion accounted for c.47% of all value creation in private equity buyouts over the last ten years (see chart 2, below). But today, with higher interest rates and an increasingly competitive fundraising environment, sponsors are often more creative in their approach to value creation, pulling all levers available. Increasingly, sponsors are turning to new technologies to facilitate this, with NAV Financing at the forefront of this evolution. Typically, the ability to generate value creation through bolt-on M&A is relatively restricted due to a lack of sufficient equity capital and limitations on additional senior or junior asset-level debt. We believe that NAV Financing gives sponsors a powerful tool to continue generating equity value in their portfolios — exactly in line with their LPs’ investment objectives.
Private Equity LPs and sponsors are seeing the benefits
Peter Hutton
Arcmont Asset Management
Given the rapid growth we have seen across other segments of private credit, we fully expect that NAV will follow suit. With subscription lines, for example, the market initially required extensive education; today that market is worth c.$900bn globally. Based on our calculations, we expect the market for NAV financing to grow from an estimated $100 billion today to around $500 billion by 2030 (see chart 3, below).
The how and why of NAV
The way NAV Financing works is relatively straightforward. At its simplest, it is asset-backed lending at the fund level. NAV Financing provides flexible capital for a variety of purposes, such as platform acquisitions, refinancing of the subscription line, repayment of asset-level debt, or — as is most common — to support one or more bolt-on acquisitions for businesses already in a sponsor’s portfolio.
Investing the proceeds of NAV Financing in the underlying assets of a portfolio (i.e. ‘money in’) is by far the most common use of this tool; according to ILPA, it accounts for 80% of all NAV Financings. Given the need for more creative value creation approaches from sponsors, we expect this percentage may move even higher.
Chart 2: Drivers of NAV usage
Arcmont expects Multiple Expansion – a key driver of sponsor returns historically – to be a less powerful driver going forward...1
... leaving sponsors to turn to follow-on M&A to help generate returns2
1 Per Bain and Company Global Private Equity Report 2024. Indexed to enterprise value at entry; includes fully and partially realized global buyout deals by year of entry; includes deals with invested equity capital of $50 million or more; excludes real estate; all figures calculated in US dollars. Sources: DEalEdge powered by CEPRES data
2 Source: Pitchbook
One of the most attractive elements of NAV loans for sponsors is their flexibility. NAV loans are most suitable for the value creation phase of a fund’s life cycle (typically years three through seven in a closed-end fund). The ability to generate additional ‘equity’ — albeit at a debt cost of capital — well into the harvest period is not only an attractive cost of capital arbitrage but also allows sponsors to execute on transformational M&A that might not otherwise have been possible.
There are other factors that make NAV loans attractive to sponsors too. The quantum of financing can be significantly larger than any single-asset financing given the collateral is the consolidated value of an entire portfolio, not just a single company’s cash flows.
NAV loans can also be relatively inexpensive when compared with top-of-the-margin-ratchet senior or junior debt at the portfolio company level — a key attraction for sponsors seeking to add value to their portfolios and improve returns for their investors.
NAV loans are typically lower risk for sponsors and their Private Equity LPs when compared with single asset financing given the typically conservative Loan to Value ratio as well as the fact NAV loans are typically PIK interest. This means that whereas traditional debt financing typically means a higher cash burden on the underlying companies and elevated default risk, a NAV loan has zero impact on the companies themselves — which we believe is why they are increasingly popular amongst sponsors.
According to our research, NAV Financing can improve net fund IRRs by an average of 100-175bps, which is not immaterial and could potentially lead to a difference in the sponsor’s performance quartile — we believe this is an increasingly important KPI especially in a challenging fundraising environment.
Simply put, we believe that NAV Financing provides all the benefit of additional equity for value creation but at a debt cost of capital with low risk attached for sponsors and their Private Equity LPs. This explains why this type of financing is being used more frequently: we believe LPs are increasingly recognizing that a fund investment is more than a series of asset-level returns. In our view, management of gross to net spread will become a key area of differentiation for sponsors.
Chart 3: Asset Class Growth Through Time
1 Private Equity Market Size Preqin. “Today” as at Jun-24: ‘10 Years Ago’ as at Dec-14.
2 Direct Lending Market Size Source Preqin. “Today” as at Jun-24; “10 Years Ago” as at Dec-14.
3 Secondaries Annual Transaction Volume as Proxy for Market Size Source “Today” Secondaries Investor (Secondaries volumes his record high of $160m – Evercore): “10 Years Ago” Secondaries Investor (Secondaries volume to reach new highs in 2014)
4 Subscription Line Market figures are based on Arcmont’s internal analysis and subject change. Analysis assumes Total Unrealized Private Equity Buyout
NAV greater than 3 years old of $2.3T (Preqin as at March 24) assuming an average LTV Radio for a typical NAV Financing transaction of 10% to derive the $230B figure. Increase in Potential NAV Financing Market is estimated by Arcmont by assuming L10YR CAGR for Unrealized NAV of c. 11% and increasing adoption from c.9% (calculated) to 30%. This estimated data has been produced for illustrative purposes only. There is no guarantee that similar trends will be experienced in the market and actual market sizes may differ significantly.
Aligning with Sponsors and their Private Equity LPs
Despite this significant opportunity, there have been suggestions by some private equity LPs that NAV loans are simply ‘leverage on leverage’. The reality of private equity today is that M&A has become a core lever in a sponsor’s value creation playbook. LPs typically put no asset-level financing restrictions on sponsors and their funds, with this additional debt increasing an individual company’s cash burden and potentially increasing its default risk. However, NAV loans — typically conservatively levered up to 20-25% LTV with risk highly diversified across assets — are a lower risk, higher return-enhancing form of leverage versus traditional asset financing. Moreover, NAV enables sponsors to capture M&A opportunities previously not possible with traditional asset financing. So, it’s not a question of ‘leverage on leverage’ rather ‘which type of leverage is most appropriate’.
NAV Financing carries less risk for sponsors and their LPs versus traditional asset financing given the portfolio diversification benefits. Even in the three worst recent macro downturns (i.e. the DotCom Crash, the Global Financial Crisis and COVID) the lowest that Private Equity valuations declined was 28% before rebounding. Given that NAV Loans are typically conservatively structured at 20-25% LTV, this means lenders are still protected by a significant equity cushion. Per Arcmont proprietary analysis available in our recently published White Paper, even in a highly punitive downside scenario a minimum equity cushion of ~50% remains at all times.
ILPA’s recently published guidelines, as well as the Loan Market Association, play an increasingly important role in edifying and clarifying the NAV environment for participants. We believe that huge strides have been made in alignment between sponsors and their LPs on the use of proceeds, transparency, and communication. Today, in our experience NAV is increasingly accepted by the most sophisticated LPs when a sensible use case is put forward by GPs. As LPs become more familiar with NAV used for M&A, we believe NAV Financing has the potential to become ubiquitous in the same way that subscription lines have.
Although NAV lending has existed for over 20 years, it is emerging now as a favourable source of flexible capital, with both Private Equity LPs and sponsors seeing the benefits. As the industry continues to embrace NAV loans, education regarding how best to deploy will be crucial to ensure their continued success and longevity. Ultimately, we believe that NAV should be regarded simply as a tool, albeit a powerful one, that is here to stay.
ABOUT Arcmont
Arcmont Asset Management, an investment affiliate of Nuveen, the investment manager of TIAA, is a private debt asset management firm providing flexible capital solutions to a wide range of businesses in Europe.
With a highly experienced investment team, a strong investment track record and deep technical expertise, Arcmont offers creative and flexible capital solutions to European businesses, with the reliability of a partner that values long-term relationships.
Headquartered in London, Arcmont’s presence spans across the region as it maintains a local origination network and builds and preserves close relationships with sponsors, borrowers and local intermediaries.
1 Arcmont estimate
2 ILPA — Guidance on NAV Facilities (2024)
3 Bain — Global Private Equity Report (2024)
4 Cadwalader — In Our Ratings Era: Top Lender Considerations for Subscription Facilities (May, 2024)
5 Arcmont analysis assumes Total Unrealised Private Equity Buyout NAV greater than 3 years old of $2.3T (Preqin as at Mar-24) assuming an average LTV Ratio for a typical NAV Financing transaction of 10% to derive the $230B figure. Increase in Potential NAV Financing Market is estimated by Arcmont by assuming L10YR CAGR for Unrealised NAV of c.11% and increasing adoption from c.9% (calculated) to 30%. This estimated data has been produced for illustrative purposes only. There is no guarantee that similar trends will be experienced in the market and actual market sizes may differ significantly.
6 ILPA — Guidance on NAV Facilities (2024)
7 ILPA — Guidance on NAV Facilities (2024)
8 These estimates have been produced by Arcmont based on a number of assumptions and subjective judgements and have been prepared for illustrative and indicative purposes only. There is no guarantee that PE Sponsors or LPs will experience similar return increases.
9 Preqin Private Equity exc. VC Historical returns — rebased to 100, as at Oct-24. NAV Breakeven case from Arcmont estimates, calculated by assuming a 20% LTV Loan increasing to c.37% LTV after 5 years of compounding at 9% PIK interest, assuming no change in the PE portfolio NAV and that no cash flow sweeps have taken place.
10 Source: Burgiss (Q4 24). Assumes a hypothetical NAV Loan in each of years 3 to 7 inclusive of a fund’s life across 2001 to 2011 vintages on the average top quartile (i.e. 25th percentile) performing fund. Then we assume a downside sensitivity whereby the fund begins to behave like the average bottom quartile (i.e. 75th percentile) performing fund.
11 ILPA — Guidance on NAV Facilities (2024)
