Originally featured in Private Debt Investor.
What are the typical use cases that you are seeing for NAV loans today and how have these evolved?
In the last two years, we’ve seen a notable shift towards NAV loans being used to increase investment capacity, with most now being deployed to finance new platform investments, support follow-on investments in existing portfolios, or fund value creation initiatives for portfolio companies. The loans are enabling funds to invest closer to 100% of commitments, which is enhancing returns for investors and lowering the proportion of management fees paid relative to invested capital.
Our bottom-up analysis this year revealed that in 2023, approximately 97% of NAV loans executed across the industry were used to increase investment capacity, while only about 3% were utilized for distributions to investors. Looking at the broader trend since 2020, around 10% of NAV loans have been used for distributions.
What types of general partner are using NAV loans and to what extent is penetration of the product increasing?
We see NAV loans being used across the full spectrum of the market, from small-cap managers to the mid-market and then through to the very biggest firms. However, it is really the largest and most experienced managers that are driving the rapid market adoption of NAV loans. They are systematically using them to turn good performance into outstanding performance. NAV lenders, meanwhile, are only interested in lending to well performing sponsors with solid portfolios, which reenforces NAV loans as a financing tool for the best performing firms.
How do you select which opportunities to pursue?
Our first priority is assessing the quality of the manager. The sponsors we’ve partnered with over the past five years have had an average of over $40 billion in assets under management, so we’re working with well-established organizations. Next, much like any primary fund investor, we closely examine the team in charge. We carefully review governance, track record and the level of support that the firm receives from its limited partners. Finally, we conduct a thorough analysis of the valuations and capital structures of the portfolio companies. Based on these factors, we structure the investment with terms that ensures our investors’ capital is protected.
Has the emphasis of your diligence changed at all in the current macroeconomic environment?
We are closely monitoring the level of leverage applied to portfolio companies and their ability to service that debt. One trend we are increasingly seeing is the re-allocation of funds, initially designated for a buy-and-build strategies, to cover higher interest payments on existing loans. We’re comfortable with this approach, provided that the underlying portfolio continues to perform well and there are no defaults.
Would you say that challenging M&A markets have boosted demand for NAV finance, or is this a product that makes sense regardless of where we are in the economic cycle?
Higher interest rates and longer hold periods have created a “liquidity squeeze” that has led to intense competition in the buyout fundraising market. In this environment, the best GPs are exploring different options to increase the capacity of their existing funds and generate as much value as possible for their investors.
I believe this environment will lead to a bifurcation of the buyout market, where you will be able to identify the GPs that proactively create value versus those that have been carried along by the low-interest environment and year on year increases in market valuations. Part of what separates a manager that delivers through the cycles from others is a willingness to use new tools, such as NAV finance.
The continuation vehicle is another piece of technology that has risen to prominence in recent years and which allows GPs to continue growing their best assets. Do you see the two as competitive or complimentary?
NAV lending and continuation vehicles serve distinct purposes and are relevant at different stages of a private equity fund’s lifecycle.
In the early years of a fund, typically the first four, the portfolio is built and managers rely on subscription lines to optimize cash flows and streamline operations for investors by minimizing the number of capital calls. Subscription finance has become a standard tool across all private equity funds at this stage.
On the other hand, the continuation vehicle market, which has matured over the past decade, becomes relevant much later in the fund life – around year 12. It allows managers to provide a final exit to investors, crystallizing performance. For GPs, it is a very valuable tool as it helps wrap up a fund entirely. Additionally, it can also be helpful for realigning carried interest allocations when the team in charge of a fund later on is different to the original team.
NAV loans, however, serve a different purpose. They are typically used between years five and 10, when the portfolio is established and the focus is on maximizing value creation. Each of these tools are designed for different stages in a fund’s lifecycle, so I don’t view them as being in competition with one another.
What do you consider to be best practice when establishing a framework around the use of NAV loans between GPs and LPs?
As the adoption of NAV finance continues, it will be increasingly important for GPs and LPs to agree on a set of guidelines for the use of NAV loans at the inception of new funds – in the same way that the use of subscription lines is negotiated and documented in the initial fund documentation with clear limits on the amount and duration of leverage.
For example, for NAV loans, there could be a provision allowing a loan of up to 10% to be secured without requiring LPAC approval, but anything beyond that threshold might need formal approval.
I would also encourage GPs to be transparent – and even proud – when reporting to their investors on the value that NAV loans have created. There are numerous case studies that highlight the significant positive impact that NAV loans have had.
How are supply-side dynamics evolving in the NAV lending space?
While there are a few more players active in the NAV finance market today, it remains underserved and far less crowded compared to markets like Direct Lending. A handful of banks occasionally offer NAV loans, typically at very low LTVs, primarily to maintain relationships and ultimately secure M&A mandates. Additionally, a few insurance companies and private credit managers engage in these transactions opportunistically.
There are very few players that are fully dedicated to NAV finance. As a result, the growing demand for NAV finance from GPs is significantly outpacing the available supply.
What impact is this having on pricing and terms?
The market has become more liquid, especially in the large-cap space, where loans tend to be slightly cheaper than in the mid-market. This is particularly true for lower LTV (sub 5%) loans that banks will likely provide to sponsors. Outside of that, pricing and terms have remained stable, with margins typically ranging between 550 and 750 basis points above base rates.
Each deal requires a customized waterfall structure to allocate proceeds from the sale of companies to either debt repayment or the fund’s investors. As NAV lenders, our goal is to build some loan duration to generate an attractive multiple for our investors. The waterfall structure must therefore ensure that LPs benefit from value creation while maintaining the same risk profile for the loans. This bespoke approach to dealmaking is a key reason why both we and our investors find this market attractive.
How would you describe LP appetite for investing in NAV funds? Why is this an appealing strategy for investors?
Investors often see NAV loans as an attractive alternative to direct lending. These loans are typically provided alongside well-established managers, with exposure to a diversified portfolio of companies that the GP has managed for several years. The terms and structure of each loan offer strong downside protection through low LTVs, covenants, and default provisions.
The ‘portfolio effect’ is another key advantage. Unlike direct lending, where the performance of a single company can significantly impact returns, NAV loans benefit from diversification—meaning even the deterioration of one or more companies within a portfolio doesn’t necessarily affect the loan’s performance. This makes the strategy more resilient across economic cycles compared to single-asset lending.
Additionally, investors value the market’s inefficiencies and the lack of heavy intermediation. Over 80% of our loans are sourced on a proprietary basis. With the NAV finance market being underserved, firms like 17Capital can be highly selective, executing around 10 investments each year from over 200 opportunities. This allows us to focus only on those that meet our risk profile and offer the best returns for our investors.
Ultimately, these factors contribute to each loan having an investment-grade equivalent risk profile, making it a compelling option for investors.
How do you see the NAV finance market evolving going forward?
I expect to see continued growth in the adoption of NAV finance. About a year ago, I spoke with a GP whose firm prides itself on having a ‘last-mover advantage’. This firm prefers to let others test new innovations before adopting the most successful ones. He said that NAV loans clearly stood out as one of those innovations they needed to embrace.
Just as subscription lines and continuation vehicles have become widely accepted, I believe NAV finance will follow the same trajectory. In fact, I anticipate that within a decade, over 90 percent of managers will be using NAV finance in some capacity.