This article is sponsored by 17Capital.
How are you seeing NAV financing grow as an asset class?
We have been involved in NAV finance for nearly 15 years as a firm. During that period, we have witnessed year-on-year growth. Over the past three years or so, however, there has been a real acceleration of that trend as market adoption has picked up significantly. In particular, we have seen increased use from larger managers – in fact, roughly 80 percent of the capital we have deployed in recent months has been alongside managers that are in the top 100 by size.
From 17Capital’s perspective, we are now able to lend across the whole NAV finance spectrum, having complemented our preferred equity offering with a credit offering as well. All of these factors have really helped to drive market growth, and we believe that trend will continue.
What has driven the increased market adoption that you have been seeing in recent years?
I think it is partly a result of increased awareness and understanding of the availability of this product and how both preferred equity and NAV loans can be used to create value. The pandemic certainly played a role in that process: during that period, traditional financing options really dried up, so managers were forced to explore alternatives. This allowed NAV finance to come to the fore.
“It is really important that the GP communicates with its LP base… We always encourage complete transparency”
At the very beginning of covid, we were working with GPs facing liquidity issues as they sought to defend portfolio companies impacted by lockdowns. That quickly switched to a focus on accessing capital to pursue growth opportunities, including bolt-on acquisitions and other value-accretive moves.
Following those experiences, managers now recognise that NAV finance can be a really useful addition to their toolkits when it comes to providing growth capital, as well as creating distributions for investors to allow them to fund their ongoing commitments. That awareness and that understanding of the flexibility that NAV finance provides has helped increase adoption and driven the transition from a niche product into the mainstream.
As you say, 17Capital offers NAV finance as both loans and preferred equity. Why is that?
NAV finance loans represent a natural extension to the preferred equity we have provided for many years. Preferred equity offers greater flexibility at a higher cost than credit.
However, you are essentially dealing with the same clients and looking to solve the same range of challenges that those clients are facing. Being able to offer both preferred equity and loans simply enables us to operate across the entire spectrum of the NAV finance universe.
What are the challenges that managers are looking to address with NAV finance? Why are they using these financing solutions?
The short answer is growth. That can manifest itself in a number of ways: managers may have exhausted the invested capital in their funds, but still see further opportunities to drive growth in their portfolio. For example, they may have identified opportunities for value-enhancing M&A. NAV finance can be a really useful tool to facilitate that growth.
“NAV finance will increasingly become a standalone asset class in its own right within the broader private debt universe”
Alternatively, managers may be looking to invest in their own firms. They may see the opportunity to launch new strategies, or move into new geographies, and seek recourse to NAV financing to drive that expansion. Financing at a management company level can also prove very useful for facilitating succession planning.
As the private equity industry continues to grow and funds continue to increase in size, the GP’s required investment in its own funds will escalate as well. We often work with organisations that are committing in excess of 5 percent to the funds that they manage; these GPs have high conviction in their own capabilities and so are looking to make outsized commitments, which inevitably places additional capital demands on those firms. NAV finance can be a useful product for allowing GPs to meet those commitments. Whatever the situation, however, it generally comes back to this need to drive growth.
Are LPs seeing value in gaining exposure to NAV finance themselves, by investing in NAV finance funds?
Definitely. We closed our first credit fund earlier this year at our €2.6 billion hard-cap, easily exceeding a €1.5 billion target. This made it the largest debut private credit fund raised anywhere in the world since 2009. We also closed our fifth preferred equity fund on €3 billion in 2021.
There is clear acknowledgement from LPs that there are strong risk-adjusted returns available from NAV finance, in both its credit and preferred equity forms. Again, as this knowledge and awareness grows, I expect that to translate into continued and enhanced investor appetite for NAV finance funds.
What alternatives to NAV finance are currently available to GPs?
To put it simply, the obvious alternative to taking on NAV finance is to sell. That could mean selling a portfolio company, selling a stake in the firm, or selling a fund interest in the secondaries market.
What NAV finance offers, by contrast, is the ability to hold on to your assets, so that you don’t have to sell a company before you are ready, you don’t have to sell a dilutive stake in your management company, and you don’t have to sell commitments in a fund if the time is not right. In turn, that allows you to continue driving growth and creating value.
How are NAV financing players differentiating themselves, and what questions should GPs be asking when choosing a partner?
The number one source of differentiation is execution experience and capability. There are very few dedicated NAV finance providers and, certainly, there are no other firms offering NAV finance right across the preferred equity and credit spectrum. We have completed more than 80 transactions, and no two deals are the same. That execution experience is critical, and that is the quality that managers should be looking for.
The current macro environment could be the first real test that the NAV finance market has experienced. How do you expect it to fare?
There is no doubt that the macroeconomic climate has shifted dramatically this year, even when compared with 2021. So far, this is translating into even greater demand for NAV finance. Our volume so far in 2022 is 35 percent higher than for the same period last year.
As rising inflation and slowing growth lead to a reduction in exits at the underlying portfolio company level, managers are being forced to hold onto their assets for longer. This is leading to increased need for fund-level solutions that allow the GP to continue to support the businesses they own. Meanwhile, on the LP side, investors are looking for creative ways to fund capital calls, or else rebalance exposures to underlying GPs.
In that sense, we are weathering this new economic environment very well, which is exactly what we would have expected. Fundamentally, growth in NAV finance is being driven by the absolute scale of the private equity industry, as well as by increased adoption as NAV finance becomes an established part of managers’ toolkits for driving growth.
Of course, it is important to remain disciplined from a risk perspective as the economic backdrop becomes increasingly volatile. It is all about being selective and ensuring you have the right structures and controls in place. We are cautious and we are prudent, but we are also very much open for business.
What’s next for the NAV finance market?
Our view is that NAV finance will increasingly become a standalone asset class in its own right within the broader private debt universe. After all, the size of the addressable market is clearly enormous: you only need to look at the $1.6 trillion of NAV that exists across European and North American buyout houses to see the potential scale that this industry has. We are forecasting a market opportunity of €700 billion per annum by 2030, and we absolutely believe this is an exciting place to be.
How do LPs view the NAV financing market today?
Like managers, LPs are starting to become more aware of NAV financing and are seeing the benefits it offers at the same time. We have definitely seen a shift in acceptance from the LP community.
It is really important that the GP communicates with its LP base, however, and we always encourage complete transparency. If LPs understand the rationale for using NAV finance and if the manager can demonstrate how its use will add value for them as well, then we see very little pushback at all. That communication is absolutely critical.
In fact, in addition to our work at a management company and fund level, we also work directly with limited partners to enable them to invest more alongside their highest-conviction managers, or else to rebalance their private equity exposures. So, I would say that LPs have fully bought into the benefits that NAV finance can offer.