This article is sponsored by Investec
What impact has the pandemic had on US and European private equity?
Matt Hansford: As soon as lockdown hit, GPs went on the hunt for defensive liquidity. They were trying to understand what the effect of covid-19 was going to be on their portfolio and what liquidity sources were available to them. Investec fielded a huge number of calls from GPs regarding net asset value financing solutions at that time and, as government support is wound down, clearly those defensive liquidity discussions are not going away. At the same time, however, GPs have quickly turned their attention to a once-in-a-generation buying opportunity, which they do not want to go to waste.
Tom Glover: PE managers have moved with alacrity in managing their portfolio companies through these treacherous waters. Equally swift has been the subsequent pivot by these GPs from playing defence to offence.
Conversations with GPs have rapidly turned to using NAV to capture value in different ways in this unique moment in time, whether through creating new dry powder to continue buy-and-build strategies, fund organic growth initiatives or make opportunistic market debt purchases. As creative GPs find new use cases, product innovation is accelerating.
What is the LP view of NAV financing solutions?
TG: LPs are expecting to be approached by GPs about specific funds that require or could benefit from additional liquidity. While LPs have accepted these are conversations that need to be had, they are also very sensitive about committing fresh capital at a time when they are already bracing themselves for a dramatic slowdown in liquidity events. They are looking to GPs to bring forward thoughtful and cost-effective solutions that don’t require further LP commitments.
NAV financing has come to the fore among potential alternatives because it brings certain advantages: it is flexible, patient, cost-effective capital that can be implemented in a timely fashion.
MH: With any innovation, there needs to be an accelerant – a spark that helps build momentum. The current crisis has certainly been providing that for NAV financing. LPs have grown used to capital call facilities, but most have had little interaction with NAV facilities so far – there has been more talk than action.
The effect of this crisis, however, is that there is a clear need for both defensive liquidity and liquidity to help GPs take advantage of buying opportunities. As a result, both GPs and LPs have upskilled themselves in their understanding of what this tool is and have begun to form a view. For the most part that view is favourable, so long as motivations are aligned.
How has covid-19 affected the bank’s willingness to lend and the practicalities of conducting due diligence?
TG: In terms of Investec’s willingness to lend, the good news is the bank is well capitalised to weather covid-19. It has been active across the various lending markets it is involved in. With regards to due diligence, generally the finance industry has adjusted well to the challenges of not being able to meet face-to-face. We have been able to use video calls and other technology to gain the level of comfort we require to make commitments.
MH: I would add that while we do take a bottom-up view on what may be a relatively concentrated base of companies, we do also have that portfolio effect, so the due diligence is different to leverage finance analysis. Our assessments are typically lighter touch and we do not need to visit the companies themselves, both because of the portfolio effect and other factors in terms of where we put our capital structurally.
Compared with the global financial crisis, how could NAV financing impact fund performance this time?
TG: When you look at the history of the global financial crisis, it is clear that a number of mid-life funds delivered weaker performance, in part because of prices paid pre-crisis, but also because a lack of dry powder prevented them from taking advantage of opportunities in the down cycle.
What we are seeing in this cycle is GPs are highly cognisant of the importance of finding ways to proactively take advantage of the crisis to improve returns. I think those managers that are able to acquire cost-effective incremental capital for these mid-life funds will be among the winners in their vintages.
What are the pitfalls of these structures and how can these be avoided?
MH: The first pitfall is failing to get the correct alignment between LP, GP and provider. All the press around the capital call space in the past couple of years has made it very clear that LPs value transparency and a thorough understanding of what value is being driven. Second, it is important to take an appropriate level of risk in the context of a specific portfolio.
Third is getting the structuring right. As an example, if a deal is structured with hair trigger covenants and there is a second wave of covid-19, that could trigger defaults and create a whole host of difficulties for the GP.
You need to take into account what could happen in the future to make sure you end up with something that is sensibly structured from a risk and covenant perspective, but also from a portfolio cash distribution perspective. Neither the GP nor the LP wants a lender to come into a high-quality situation, with real diversity and low underlying risk, and then take all the distributions.
What does the future hold for NAV financing beyond the current crisis?
MH: Product innovation is generally driven by a market event and I think this crisis will see an acceleration in NAV financing.
LPs and GPs will gain a greater understanding of the tool and form views of where their tolerances lie. I also expect we will start to see other uses for the product. It may be used to accelerate distributions to LPs, filling some of the gaps resulting from delayed exits. We may also see derivatives of today’s product being used to help GPs with gaps in their own liquidity when it comes to financing commitments to their own funds.
I liken it to the GP-led secondaries market which really grew out of the global financial crisis, evolving from something people viewed as only for zombie funds, to a rich array of tools that provide liquidity to investors to extend the ownership of assets within a GP. I see NAV financing going on a similar journey.
Tom Glover and Matt Hansford are co-heads of Investec NAV Financing