Net asset value facilities are useful to mature funds that have called and invested a significant level of LP commitments in acquiring a sizeable portfolio. The reduction in capital commitments will result in the subscription line diminishing and, eventually, becoming unusable. A NAV facility enables these funds to access liquidity by borrowing against a proportion of the NAV of their portfolio, typically outside the scope of the restrictions in the fund’s governing documents.
The assets of the facility may be the general diversified portfolio of the fund, or the GP fund, and the lender may cherry pick a number of specific assets on which to base the facility. The borrower may be the fund itself or, more commonly, a wholly owned special purpose vehicle. The lenders will take security over any bank accounts into which distributions and liquidation proceeds of the portfolio are paid and over equity interests in any holding companies that own the portfolio assets.
Many GPs use the proceeds of NAV facilities to affect a dividend recap, accelerating distribution to paid-in for investors and helping to improve internal rate of return. This can be particularly attractive in emerging markets, where the average holding period for assets exceeds the five to seven years of traditional buyout funds in more mature markets. The ecosystem for secondary trading of LP interests is still developing.
The simple availability of additional liquidity from a NAV facility can particularly assist funds in emerging markets. Fundraising activity for this asset class has seen a general decline since 2014/15 (with the exception of Asia, which experienced a steady rise until 2018), both in absolute terms and as a percentage of annual global capital raised, according to EMPEA.
This trend is unlikely to be reversed in the short term given the global health and economic crisis, and international trade tensions. Although the fundraising pace is expected to rebound in the medium term, in the current challenging environment, NAV facilities represent a valuable alternative source of capital for mature emerging markets vehicles.
NAV facilities also provide an alternative source of funds to finance portfolio acquisitions, follow-on investments and capital expenditure, as well as effecting asset-level refinancings and restructurings. These transactions can also be completed more quickly and flexibly than by drawing down capital from investors. The ability to draw on a facility for these purposes can mitigate the risk of a GP running out of capital in an existing fund before being able to launch a successor, which is not uncommon in emerging markets.
In considering NAV facilities, however, GPs should be cognisant of certain factors peculiar to emerging markets funds. These vehicles will generally face a mismatch between the currency in which their loans are denominated and that of their portfolio investments. This exposure to often volatile local currencies can quickly erode the value of a fund’s investments. As a result, compliance with loan-to-value covenants in a NAV facility may be at risk. A borrower should pay careful attention to the LTV ratios required by the lenders and ensure currency risks are adequately hedged to mitigate the risk of a LTV-related default. This could also be achieved by limiting the borrowing base to assets whose operations provide for a “natural” currency hedge, such as companies with hard currency revenues.
In addition, the willingness of financial institutions to lend against a portfolio of assets depends upon their ability to assess the value and risk of those assets.
When dealing with emerging markets investments, the number of lenders who can perform such sophisticated analysis on potentially unfamiliar assets and jurisdictions has traditionally been relatively limited. Those lenders who are able to do so will set out criteria for eligibility, which an asset must satisfy in order to be borrowed against.
Further, assets considered eligible will be subject to concentration limits, including to geography and sector. Although this is less likely to impact generalist funds, it may be an important consideration for sector or geography specific products. Accordingly, the LTV ratios being offered are likely to be lower and pricing higher, compared with NAV facilities granted to non-emerging market borrowers.
Notwithstanding these considerations, NAV facilities are a flexible tool whose structure and provisions can be adapted on a deal-by-deal basis to address the specific needs of the borrower. They retain the potential to be a valuable option for GPs operating in emerging markets. As the universe of lenders active in this space grows and their familiarity with the underlying assets increases, pricing is likely to drop. Given the variety of ways NAV facilities can enhance investment performance, we foresee a continued expansion in the number of emerging markets funds that will utilise the benefits of such facilities.
Aleks Bakic is a partner at Akin Gump’s investment funds practice. He advises European and emerging markets private fund sponsors on all aspects relating to the formation and operation of their funds, as well as secondaries transactions including fund restructurings. Amy Kennedy is a partner at Akin Gump’s finance practice. She structures leveraged financing arrangements for complex leveraged buyouts and other private equity transactions. Karen Ireland is senior counsel in Akin Gump’s finance practice. She advises on a broad range of international finance matters, with particular expertise in fund financing solutions.