Private Fund CFO, Amy Carroll
What is NAV finance being used for today and who is using it?
The primary reasons for utilizing NAV finance are two-fold: the provision of additional capital to fund growth opportunities and the acceleration of liquidity to investors. Meanwhile, there are three primary categories of borrowers – funds, GPs and LPs.
Funds are using NAV finance to scale their portfolio companies and fund bolt-ons, for debt refinancing and repurchases at the portfolio company level, and for accelerating distributions to investors. Meanwhile, GPs are turning to NAV finance as an alternative to a stake sale in order to meet a whole range of objectives, from making larger GP commitments, launching new strategies, entering new geographies or equitizing the next generation. Indeed, ownership transition is a major theme. The industry is only around 40 years old and there is a large amount of equity value in management companies with first-generation owners that will ultimately need to change hands.
There are a whole range of NAV financing opportunities serving the LP community as well. An extended less optimal monetization environment has slowed distributions to LPs and has many looking to NAV finance to generate liquidity off their illiquid portfolio, while staying invested and retaining future upside. They are using it to invest more behind their favorite managers in what they expect will be relatively attractive vintage years or else to meet capital calls from existing allocations or to rebalance their portfolios.
Do you believe that NAV financing will take market share from secondaries sales?
NAV finance is not a replacement for the secondaries market, but there are many cases where a non-dilutive, self-liquidating and non-permanent solution is more attractive to a counterparty than a sale. That includes NAV finance being used as an alternative to selling a portfolio company, or a stake in a management company, or to selling a fund interest as an LP. It is particularly attractive in a market where value discovery is a challenge or where there is substantial upside potential remaining.
Do you see new use cases for NAV finance emerging in the future?
Over our 15-year history, we, along with our counterparties, have continued to develop new use cases across the private equity ecosystem on a regular basis. As awareness of NAV finance benefits grows and as experience of using the product becomes more widespread among borrowers and allocators, we anticipate that this will become a tool that is used regularly in many areas, as well as a special case tool to be used in situations that we may not foresee today.
NAV finance can be applied to almost any situation where there is a desire to invest further in private equity or to generate liquidity off private equity assets or, indeed, a combination of both. For example, we are currently seeing use cases where GPs and LPs are coming together and using NAV finance to solve each other’s respective challenges and capitalize on mutual opportunities
Is NAV finance primarily a cyclical product or do you see secular growth?
We firmly believe that NAV finance is an all-weather strategy. We have witnessed this through the consistently accelerating adoption over the past three to four years in very different market environments. In periods of dislocation where there are differences of opinion between buyers and sellers on valuation, demand for innovative financing tools naturally grows. But equally, in buoyant markets, NAV financing gives firms the flexibility they need to pursue growth plans.
From the point of view of the investors that are allocating capital to NAV finance funds, it is clear that this is a product that delivers attractive risk-adjusted returns throughout the cycle,
with a combination of diversification, downside protection and low volatility. NAV finance has multiple use cases and will remain relevant whatever the macroeconomic backdrop.
What does it take to be successful in this market?
Borrowers value experience, creativity and certainty of execution. Meeting those three objectives is critical. At 17Capital, we offer the full range of NAV finance solutions across preferred equity and loan structures with the ability to apply those products across the entire private equity ecosystem, from fund to management company to LP. We also have deep expertise across all relevant skill sets required to make these deals work: secondaries, leverage finance, valuation and strategic advisory, and risk management. We have executed approximately 100 bespoke transactions and fully exited nearly half that number. I think these factors give us a unique position in the market.
How accepting are LPs of NAV finance today?
Like managers, LPs are becoming more and more educated about NAV finance and the value it can bring. The current environment is encouraging them to seek out alternatives to secondaries sales in order to continue investing alongside their highest conviction managers. That, in turn, is helping them appreciate the various use cases that exist in other areas of
the private equity ecosystem, and how LPs will benefit from its use.
Indeed, LPs are witnessing the largest and best performing GPs utilizing NAV finance today. Over 80 percent of our commitments in 2022 were made to GPs in the top 100 by AUM. Observing these kinds of managers having positive experiences with NAV finance is helping LPs get comfortable with the value creation that it brings.
Of course, these same allocators are also recognizing the opportunity that investing in NAV finance products can offer. We raised our fifth strategic lending fund of $2.9 billion in 2021 and a €2.6 billion credit fund in 2022. That strong demand reflects a recognition that NAV finance offers attractive risk-adjusted returns across
the spectrum from preferred equity to loans.
What is the scale of the potential market opportunity?
For us, NAV finance is all about the unrealized value that exists in private equity. There is somewhere between $5 trillion and $7 trillion in the private equity asset pool today, and allocations to private markets are expected to outpace those to public markets going forward, so that pool is only going to grow.
Meanwhile, we believe we are still at the early stages of the adoption curve. Take-up will continue to increase, driven by the flexibility, ease of use, and value-enhancing benefits that NAV finance offers. All in all, we believe NAV finance will become a $700 billion market by 2030, with additional upside potential.