Originally featured in Private Funds CFO.
Originally featured in Private Funds CFO.
How would you describe the scale of the market opportunity for NAV financing today and what are its various use cases?
The size of the addressable market is 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. There are two primary use cases. The first is the provision of additional capital to fund growth opportunities. The second is the acceleration of liquidity for investors. In both scenarios it is about funding the growth of best-in-class GPs to create value for their limited partners.
What is driving the growth that we are seeing in this space?
The growth we are seeing in NAV financing is driven first by the growth of the overall private equity industry and second by market adoption. As a result of those two driving forces, 17Capital has deployed over $4 billion in NAV Financing over the last 12 months. What is important to note, is the quality of the GPs that have utilized our capital. Over 80 percent has been deployed alongside managers that are in the top 100 by size and in recent months, we have worked with three of the top ten managers globally.
Do you believe that NAV financing will also be adopted by mid-market players, or is it primarily a tool for the biggest houses?
I believe it is a tool that will be used by best-in-class GPs that have conviction in the growth opportunities ahead of them, irrespective of their size. We see interest from mid-market specialists, as well as global asset managers. And that interest spans both preferred equity and credit, also known as NAV lending, solutions. We are typically most relevant between year four and year 11 of a fund’s lifecycle, for any quality GP looking to accelerate distributions or invest more in the underlying portfolio to create value for LPs. For now, we are focused on the traditional buyout space.
What were your experiences of NAV financing through the pandemic and what were the experiences of GPs that were using this product?
At the very beginning of covid, GPs were intensely focused on shoring up liquidity and wanted to understand how they could use NAV finance in the event that their portfolios required support. This acted as an accelerant for market awareness of NAV Finance and its advantages, ultimately driving GPs to utilize our capital to pursue opportunistic growth through the recovery. A typical example was a GP looking for financing to execute follow-on acquisitions and other types of value accretive moves.
NAV financing is typically associated with fund-level solutions, but what other applications does this market encompass?
We apply NAV financing solutions across the entire spectrum of the private equity industry. We work at the fund level and with fund managers at their management company to help support the growth of their franchise. We also work with limited partners to enable them to invest more alongside their highest conviction managers or to rebalance their private equity exposure.
How does a GP financing solution at the management company act as an alternative to the sale of an equity stake?
NAV financing has emerged as an alternative, or complement, to the sale of a minority stake in the management company, enabling GPs to put in place a capital structure that creates better alignment of interest with their under- lying LPs. The other advantage of a NAV financing approach over the sale of an equity position is that we are passive investors and the solutions we offer are self-liquidating, rather than permanent. As a result, the GP team retains the upside in the growth of their firm without dilution.
What is driving interest in this type of solution?
The private equity industry, in general, is becoming much more capital intensive. Fund sizes have grown dramatically over the years, which means the GP commitments, or co-invest, have also grown dramatically. We typically work with organizations that are committing in excess of 5 percent to the funds that they manage. These are GPs who believe in themselves and want to maximize the size of their co-investment, which inevitably places additional capital demands on those firms. Financing at the management company level can also prove very useful for facilitating succession planning, enabling a future generation of partners to buyout their retiring colleagues.
You mentioned the importance of alignment with LPs. How are LP attitudes to NAV financing evolving?
There is more market awareness today than ever before. The fact NAV financing is being adopted by some of the biggest and best performing GPs has also helped LPs become more supportive of this product. In fact, we have come across several opportunities that have been created by investors actively recommending their GPs to consider NAV financing. Transparency with LPs is absolutely critical, along with a strong and clearly communicated rationale for the use of the capital and the subsequent plans for value creation.
What changes are you seeing with regards to the makeup of the lending community and how are players differentiating themselves?
From a competition perspective, we see relatively limited participation by banks. Where banks are active, it tends to be at the low end of the LTV spectrum and in situations where there is a highly diversified underlying port- folio. 17Capital differentiates itself in the market based on its broad offering, from NAV lending to preferred equity. Moreover, we apply these products across the entire ecosystem; at the fund level, management company level and with LPs, which is something we have seen very few financing providers doing.
What should a potential NAV borrower be looking for in a potential lender?
I would say that execution capability and creative thinking are both really important. We have completed over 80 transactions in the NAV financing market over the past 15 years so we have that expertise. Each one of those 80 deals was very different – tailored specifically to the individual circumstances of the borrower and the liquidity profile of the assets, and so that creativity piece is critical too.
How do you expect demand and supply for NAV financing to respond to a more volatile economic environment?
This is a question that is at the top of everyone’s minds. We are seeing rising inflation and slowing growth which has already translated into a reduction of exits at the underlying portfolio company level over the past six months. That, of course, means that managers will be holding onto their assets for longer, which is generating increased demand for fund level solutions to ensure that GPs have the liquidity they require to support the businesses they already own. Meanwhile, we are also seeing additional deal flow on the LP side as investors look for ways to fund new commitments, meet capital calls and rebalance their exposures to underlying GPs.
And what about from the lender’s perspective?
At 17Capital, we have already invested throughout all stages of the cycle, having started out in this market in 2008. Our approach has always been to focus on partnering with best-in-class GPs that have the expertise to manage their underlying portfolios through difficult times. This is key.
We have ascertained that LPs are increasingly comfortable with their GPs taking on NAV finance. But how would you describe LP appetite for participating in the provision of these products themselves?
LP appetite for funds like ours has in- creased significantly. Investors recognize the attractive risk/reward profile that is on offer. We closed our debut credit fund on €2.6 billion just a few months ago, while we raised $2.9 billion for our fifth preferred equity fund in July last year.
Bringing all the positive driving forces you have mentioned together, just how big do you believe the NAV Financing space could ultimately become?
Approximately 15 percent of GPs are using NAV financing today and we have completed over $4 billion of NAV financing transactions in recent months. Adoption is increasing sig- nificantly. On that basis, I think it is reasonable to believe that somewhere between two-thirds and 80 percent of managers will ultimately turn to this type of product, which would put this at a $700 billion market opportunity.