Reed Smith Responds to ILPA’s Guidance on NAV-Based Facilities: Clarifications and Insights

We refer to the ILPA (Institutional Limited Partners Association) guidance note entitled NAV-Based Facilities – Guidance for Limited Partners and General Partners published on 25 July 2024 (the Guidance). We are issuing this client alert in response to the Guidance and information set out within the Guidance with the purpose of providing the Reed Smith perspective on the use of NAV facilities. While we are encouraged by the work that ILPA has done preparing the Guidance, we wish to clarify a number of the statements that ILPA has made in the Guidance and which are highlighted in red below, together with the Reed Smith response. Our general position continues to be that NAV facilities are a useful tool that permits GPs to manage the cashflows and timing issues associated with operating private equity funds.

ILPA Statement: “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 fund subsidiary, together with a preferred equity interest in the fund’s income and distributions from the fund investments.”

Reed Smith Response: We agree that in most NAV facilities to PE funds there will be bank account collateral provided over the account into which distributions from underlying investments are paid. However, in our experience, it is not usual for the NAV lenders to have any sort of preferred equity interest in the fund’s income. A NAV lender will generally have a prior claim on any distributions that come up from the portfolio on an insolvency or bankruptcy as the NAV lender will be a creditor of the borrower rather than the investors who are equity holders, but there are a limited number of instances where we have seen preferred equity interests issued to lenders. Unless there is an LTV breach or other default, it is not usual for the NAV lender to receive a full cash sweep of distributions ahead of the investors. Depending on the strength of the sponsor and change of control restrictions in shareholders’ agreements in the equity structure, there may also be a pledge of, or security over, the equity interests in some or all of the portfolio.

ILPA Statement: “NAV-based facilities often involve creating two special purpose vehicles, or SPVs. The first SPV is created to incur the financing under the NAV facility and hold the equity interest of the second SPV (Holdco), which aggregates the underlying fund interests in the borrowing base”

Reed Smith Response: This would be an ideal situation for a NAV lender that was providing a limited recourse NAV facility to a PE fund to ensure that there was no recourse to the fund or need for the fund to sign anything in connection with the transaction. However, in many instances the PE fund has not been set up with this double Holdco structure and the fund may be reluctant to restructure the existing equity structure to accommodate a NAV facility. We have seen deals with a single umbrella Holdco borrower under the fund or a newly created finco entity that borrows the debt and on-lends into the equity structure, or indeed the fund itself borrowing the debt if this is permitted under the LPA. The structure of each NAV transaction needs to be looked at on a case-by-case basis and so it is dangerous to generalise as to what a financing structure will often look like.

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