Originally featured in Private Debt Investor
Originally featured in Private Debt Investor
Historically, what have been the options available to GPs and LPs in their liquidity of a management company, in order to generate growth capital and liquidity
When we are talking about creating liquidity for investors in private equi-ty portfolios, we are usually referring to making capital available either for further investment into the portfolio or to release cash back to shareholders or LPs.
Whether the borrower is a fund, a management company, or an LP, the options historically available at the portfolio level have generally involved selling some, or all, of the assets in the portfolio to generate that liquidity.
For a fund, a manager could either do a traditional sale of one or more of the assets, or more recently, in a less traditional way, they could sell assets or more recently, in a less traditional way, they could sell assets into a continuation vehicle. They could even look to do a strip sale across the whole portfolio, selling a slice of everything. But the liquidity options generally involved sales rather than holding onto those assets.
At the management company level, they might be looking for capital either to grow the balance sheet, for example to make larger GP commitments into new funds or to seed new strategies, or to release liquidity, as part of a succession planning exercise. Historically, again, typically the owners have had to sell part of their business in the minority stake market where strategic investors have bought 15 or 20 percent of a management company, in order to generate growth capital and liquidity.
Similarly, for the LPs what could they do to generate cash from a private equity portfolio? Again, the main option was to sell, in this case in the secondary market, either all of their portfolio, some funds, a parallel strip or similar, to a secondary buyer in order to generate that cash.
The key thing is that in all situations the primary option at the portfolio level has been selling.
In what situation would a GP choose to use NAV financing? And an LP?
The reason that GPs and LPs choose NAV financing is because they would like to generate some liquidity, but they don’t want to sell. Generally, and most obviously, that is because they continue to have conviction in their portfolio and they do not want to lose the future upside, but there can also be more practical reasons. In a sales process the parties need to agree on a price, which is not the case in a financing transaction. As a lender, we will clearly want to be comfortable with the value of the portfolio and the amount of financing we are providing, but this is naturally easier to agree than an actual sales price. This means that a financing transaction is usually quicker to execute with a more streamlined process. In a sales process the parties need to agree on a price, which is not the case in a financing transaction. As a lender, we will clearly want to be comfortable with the value of the portfolio and the amount of financing we are providing, but this is naturally easier to agree than an actual sales price. This means that a financing transaction is usually quicker to execute with a more streamlined process. Sometimes it is more efficient, rather than selling or refinancing an individual position, to refinance the portfolio as a whole. With NAV financing, you can raise significant liquidity across the whole portfolio in a single transaction, as an alternative to multiple transactions at asset level. And finally, NAV financing is not a permanent option, because, once we have been repaid as a NAV lender, we are out of the picture and the investor continues to hold the portfolio. This is different to selling a position, which is really a permanent transaction. These dynamics are the same for both GPs and LPs: NAV financing is appealing because it is non-permanent, non-dilutive, allows the investor to keep the upside and is efficient to exe- cute; investors can generate significant amounts of liquidity without going down the sale route.
Are current market conditions boosting demand for NAV financing due to longer hold periods?
Right now, with what’s going on in the world, it is more difficult to sell assets because buyers and sellers are struggling to agree on price at a time when markets have moved quite a bit. Managers are having to hold onto assets a little longer than previously anticipated. In this situation, where manager need to continue to grow their businesses for longer, and where M&A is a key part of their investment thesis, there is an increased demand for capital to finance that M&A. With capital markets continuing to be challenging, GPs are turning to NAV financing at the portfolio level to generate liquidity to fund that growth. This is as an alternative to acquisition financing at the individual company level, which is tight in the current environment. Longer hold periods also mean that distributions back to investors is slowing down, and NAV financing can similarly help here. A recap at the portfolio level can generate liquidity so that the manager can continue to make distributions back to LPs in an otherwise slower period. As a result, we have seen a significant pickup in activity, and we expect that to continue as exits are delayed and the corporate finance market is not fully up and running. Our pipeline is very strong and, in this environment in particular, NAV financing is an attractive option.
What do LPs find attractive in investing in 17Capital funds/this strategy?
There is increased appetite among LPs for private credit generally. With our strategy, they are exposed to private equity (like investing in a direct lending fund, or a buyout fund) but with significant downside protection. All our deals are structured with equity buffers/appropriate LTVs, and diversification across a number of different businesses in every transaction. We don’t finance portfolios where there is inherently a lot of volatility, such as venture. Remember, we focus on performing portfolios of established businesses in developed markets – not stressed or distressed. At a time when equity markets have been hit hard, the downside protection we offer is proving very attractive for investors.
You recently launched a credit strategy – what is driving demand from borrowers for credit there, over your longer established preferred equity funds?
Our longer-established preferred equity funds provide flexible financing solutions, which can mean very tailored, longer dated and higher loan-to-value transactions. The idea of our newer credit strategy is to provide lower risk financing transactions at a lower price point. A few years ago, before we had the credit strategy, we had managers that really liked what we were doing, who were looking for financing against their private equity portfolios, but maybe they didn’t need all the flexibility that we were offering, or they wanted smaller amounts of capital in LTV terms. We simply didn’t have an offering for the lower risk/return profile of those transactions, which is what led us to launch our credit strategy. It didn’t change what we do, it is still all NAV finance, but it has significantly broadened the spectrum of NAV financing solutions that we can provide. Pretty much everything we do in our credit strategy is at fund level, so the focus there is entirely on 5-25 percent LTV NAV loans into buyout funds. What is driving demand here is that we offer a flexible financing tool to help managers with portfolio management at fund level. GPs are increasingly seeing the benefits and adopting NAV financing as a powerful tool to drive performance. As mentioned earlier, the current environment is accelerating this, but the growth continues to be more about awareness and adoption generally. There are trillions of dollars of NAV in private equity funds, and only a very small part is financed today.
How has NAV financing grown as an asset class in recent years?
We have seen a general trend towards growing awareness in the market of this as a product, with more and more adoption by more and more managers– particularly at the top end. The use cases are wide and varied, including top-up capital to further grow the portfolio, capital for specific companies in the portfolio where asset level financing is more challenging, or to fund an accelerated distribution to LPs. That is still the driving force behind growth. The macro trends, in terms of the current economic environment, are helping fuel demand, but it is mostly about more managers seeing the power of the NAV financing solution and becoming aware of how it can help them.
What are the current hurdles to further growth in the NAV financing market?
Supply of capital probably remains the real hurdle for market growth in the medium term, because demand is far outweighing the supply, primarily because of the limited number of established, dedicated market participants like 17Capital. The other hurdle is continuing to educate the market on how these transactions are structured and how we ensure that all stakeholders are aligned. Those tend to be the issues that people want to get comfortable with, and we are able to address all those things when we speak to people about NAV finance.
How big could the NAV financing market get based on your current estimations?
Private equity is large and growing so that is obviously an important factor in terms of continued growth of this as a strategy. And then there is adoption and awareness, where the number of managers waking up to this opportunity continues to grow. When we look at how private equity managers adopted subscription lines 15 years ago, and how continuation funds started off, we think NAV financing will follow the same trajectory and become similarly widely adopted. Not everybody is doing this yet but as more see their tier one competitors and peers doing it, we think the market will continue to grow fast. Based on those dynamics, our estimation is that the market will be worth $700 billion-plus by 2030, compared to around $100 billion in 2022. And that is in our focus market of buyout funds in developed markets– we are not talking about real estate, infrastructure, venture or emerging markets. There is a lot of growth to come in our space in the next seven to eight years, and the main driver of that is going to be more and more managers seeing the benefits of NAV financing as a portfolio management tool.