The Institutional Limited Partners Association (ILPA), representing institutional investors in the private equity industry, has recently issued comprehensive guidance regarding fund-level NAV (Net Asset Value) facilities for LPs and GPs. These guidelines offer a constructive starting point for fostering discussions between GPs and LPs, helping LPs understand the mutually beneficial applications of these facilities while raising GP awareness of LP transparency needs. 

Overview of Current Market

NAV facilities, which are credit lines secured by the value of a fund’s investments, are becoming increasingly popular among GPs for managing liquidity and supporting fund assets. While these facilities have long been used in secondary markets, private credit, and real estate, their adoption in private equity strategies has surged in recent years. 

The guidance aims to establish clear practices and disclosure norms regarding NAV facilities, particularly when structured as asset-based debt at the fund level. It emphasizes the importance of transparency and effective engagement between GPs and LPs in utilizing NAV financing as a strategic tool. 

Investor Concerns 

The ILPA guidelines highlight several key concerns from LPs regarding NAV-based facilities: 

  • Limited Insight: LPs often lack visibility into when and how NAV-based facilities are utilized.

  • Lack of Governance: There is minimal governance surrounding these facilities, leading to transparency issues.

  • Inconsistent Practices: Where Limited Partnership Agreements (LPAs) are silent on NAV facilities, GPs have adopted varying approaches, with some interpreting traditional borrowing provisions as sufficient authority to engage in NAV facilities without LP notification.

  • Use of Proceeds: Concerns arise when NAV facilities finance distributions to LPs, potentially creating adverse tax implications and misaligning GP and LP interests.

    Despite these concerns, the predominant focus on funding distributions may overlook the more beneficial uses of NAV facilities for portfolio support and value creation. This discrepancy underscores the need for enhanced dialogue between GPs and LPs, clarifying the appropriate conditions for NAV facility use and the disclosures LPs deserve. If the ILPA guidelines foster such discussions, they represent a positive step forward. 

    ILPA Recommendations 

    For older funds, which often benefit most from NAV-based facilities, many LPAs do not explicitly address their use. While some GPs argue that the absence of a prohibition allows for NAV facilities, others proactively engage their LP Advisory Committees (LPACs) to ensure buy-in before implementation. 

    Rather than advocating for outright prohibitions on NAV facilities, the ILPA guidelines encourage improved LP/GP communication at both fund inception and during consideration of specific NAV facilities. 

    The guidelines recommend incorporating clear provisions about NAV facilities into new LPAs to ensure that investors understand the potential leverage and associated risks. Key recommendations include: 

  • LPAC Consent: GPs should seek LPAC approval for NAV facilities unless the LPA expressly permits otherwise.

  • Conflict of Interest Review: Any potential conflicts related to NAV facilities should be brought to the LPAC’s attention.

  • Separate Approval for Distributions: GPs should obtain LPAC approval before using NAV facility proceeds for distributions.

  • Standardized Disclosure: GPs should provide standardized disclosures about NAV facilities, including rationale, size, amounts borrowed, LTV at borrowing, interest rate, and term.

    This measured approach promotes communication between GPs and LPs, balancing the need for GP flexibility with LP transparency. 

    Conclusion 

    General partners should anticipate heightened inquiries from limited partners regarding NAV financing throughout various stages such as initial diligence, fundraising negotiations, and ongoing portfolio monitoring. To prepare effectively, GPs should conduct audits of current forms and reporting practices related to NAV facilities, align reporting with ILPA recommendations, and familiarize themselves with ILPA’s suggested diligence questions to address LP concerns.  

    Review the complete guidelines here: https://ilpa.org/wp-content/uploads/2024/07/ILPA-Guidance-on-NAV-Facilities-2024.pdf