NAV-based facilities – ILPA publishes recommendations

The Institutional Limited Partners Association (ILPA) has published a report, "NAV-Based Facilities Guidance for Limited Partners and General Partners" (the Guidance).

What does the Guidance cover?

As the Guidance notes, while Net Asset Value (NAV)-based financing facilities have been common place with secondaries, private credit, and real estate for some time, it's only relatively recently that there has been a significant increase in their use in private equity strategies.

Given that older Limited Partnership Agreements (LPAs) often fail to address NAV facilities in detail, differing approaches have developed among General Partners (GPs) around their use and a range of different approaches to reporting has emerged.

The Guidance puts forward general parameters for

• improving transparency and

• encouraging a more productive dialogue between LPs and GPs around NAV-based facilities.

It also sets out recommendations around the use of NAV facilities for private equity strategies where the facility is structured as asset-based debt at the fund level.

Note that the Guidance does not address the use of NAV-based facilities in other contexts, such as secondaries, private credit, or closed-end real estate funds.

The Guidance also makes clear that its recommendations are not intended to be universally appropriate or applicable in every instance.

Simmons view:

Although we have seen an increase NAV-based facilities in the past 18-24 months, the market is still growing and evolving. With this in mind, we welcome the fact that ILPA has sought to provide guardrails without being too prescriptive. ILPA also recognises that these facilities can be a useful tool to provide interim liquidity and support to portfolio companies. In our view ILPA has managed to strike a delicate balance in providing a set of governance norms whilst leaving room for the market to develop.

This note sets out the key points covered by, and the main recommendations made in, the Guidance.

What are NAV-based facilities

For the purposes of the Guidance, ILPA defines NAV-based facilities as "credit facilities, backed by the value of the fund's investments" (as opposed to subscription lines, which are backed by the undrawn commitments of fund LPs) and which can be structured to cross-collateralize the equity of multiple portfolio companies.

The collateral used in NAV-based facilities is generally cash received in the bank accounts of the borrowing entity (i.e., the fund or a subsidiary), together with a preferred equity interest in the fund's income and distributions from fund investments. It can also extend to a direct pledge of the fund's investments.

ILPA notes that NAV facilities tend to be employed:  

• after the fund's remaining commitments have been drawn down

• following the end of the investment period

• once any reserve capital has been exhausted.

Although some GPs have taken the approach that the SPV is outside of LPA restrictions on borrowing so does not count towards the calculation of fund-level indebtedness, the view of ILPA is that NAV-based facilities do, indeed, constitute fund-level indebtedness and should be included in borrowing limitations.

Recommendations

Among the recommendations made in the Guidance are the following

• the GP should receive prior consent from the Limited Partnership Advisory Committee (LPAC) to use a NAV facility (unless this is expressly permitted by the LPA)

• such engagement should encompass

  • the rationale and use of proceeds

  • the size, structure and controls

  • key economic terms

  • LP obligations (for example, whether distributions received are recallable).

• a GP should also seek approval from the LPAC where it intends to use proceeds to generate a distribution. On the basis that the GP received prior consent to use a NAV facility, it should not need separately to seek the LPAC's consent to use a NAV facility to support the portfolio - however, the GP should disclose the fact that it is implementing a NAV facility to support the portfolio to all LPs.

• new LPAs should address NAV-based facilities, with provisions defining limits to the amount of borrowing a GP is able to incur through NAV-based facilities throughout the life of the fund

• the Guidance does not recommend a specific percentage threshold to limit the amount of NAV-based facility exposure. Instead, this should be determined by the LPs/GP during negotiations based on the fund strategy and risk factors. Nevertheless, a clear limit is essential in order for LPs to be able to understand the risk

• LPs should treat with caution any provisions in the LPA which give GPs broad authority to implement NAV-based facilities with little LPAC or broader oversight. Rather, the LPA should require a GP to obtain LPAC / LP approval for any conflicts of interest associated with a NAV-based facility.