ILPA Issues Guidance on Net Asset Value–Based Credit Facilities

The Institutional Limited Partners Association (ILPA) has released new guidance for limited partners (LPs) and general partners (GPs) on net asset value–based facilities (NAV Facilities). NAV-based lending, a type of financing in which loans are backed by the underlying portfolio investments of a fund, has seen a surge in usage in private equity strategies as funds seek additional liquidity, including in challenging economic environments.

This growing trend is only expected to continue: the Fund Finance Association estimates that the market for NAV Facilities is currently $100 billion and is expected to grow to $600 billion by 2030.[1] Common uses for proceeds from a NAV Facility include to create an early distribution to LPs, fund follow-on investments, and/or support the fund’s underlying portfolio of investments.

The growth in the number of NAV Facilities has brought increased concerns from some LPs regarding its usage, mainly in relation to the transparency and varied practices of GPs in managing these facilities:

• Lack of transparency: Some LPs will often have limited insight when NAV Facilities are being used and as such are not able to fully evaluate their investment.
• Lack of governance: The lack of governance related to the use of NAV Facilities drives the lack of transparency since NAV Facilities are oftentimes put in place later in the life of a fund (i.e., once the fund investment period has ended or is close to its end, or once all of the commitments have been drawn), and the limited partnership agreements (LPAs) tend to have been drafted without provisions specifically dealing with NAV Facilities.
• Inconsistent approaches taken by GPs: Where the LPA is silent on the usage of NAV Facilities, the approaches taken by many GPs have ranged from
  • seeking broad approvals from the LPs or the Limited Partner Advisory Committee (LPAC) to use NAV Facilities during the life of a fund (rather than requests for a specific NAV Facility); and
  • GPs interpreting fund-level leverage provision in LPAs as providing sufficient authority to undertaking NAV Facilities without LP or LPAC notification or engagement.
• Use of proceeds and expenses: Some LPs have expressed concerns regarding the use of NAV Facilities to fund early distributions (which are often recallable) as well as the impact on the internal rate of return/Distributed to Paid-In Capital and the potentially high costs of putting these facilities in place.

The ILPA guidelines seek to address these concerns by focusing its recommendations around two key themes, disclosure and LPAC engagement:

• Transparency: ILPA recommends that, to the extent an LPA does not give explicit permission to utilize a NAV Facility, or if the LPA does give such permission and the proceeds of such NAV Facility will be to fund distributions, GPs should seek LPAC consent prior to implementing NAV Facilities and ensure that LPs are provided with details of, among other things, the use of proceeds, the size of the facility, the proposed structure and use of SPVs, the costs, and LP obligations. Even if an LPA expressly permits the utilization of a NAV Facility and the proceeds are being used for a purpose other than funding distributions, the recommendation is for the GP to inform the LPAC about its intent to use a NAV Facility. To aid these discussions, ILPA also provides a set of questions as a resource to support LPs when entering into discussions with GPs (set out in part 5 of the guidance), with the aim of helping LPs understand and assess the impact of a proposed NAV Facility on a fund’s risk profile and returns.
• Legal documentation: The ILPA guidelines recommend that express provisions addressing the use of NAV Facilities be incorporated into new LPAs to ensure an agreed set of guardrails around permissible uses of a NAV Facility, reporting obligations, size limits on the amount of leverage that GPs are permitted to incur, etc.
• Ongoing disclosure: ILPA recommends that GPs provide all LPs with a set of standardized disclosures about NAV-based facilities once they have been put in place. These standardized disclosures are set out in part 5 of the guidance.

The full ILPA guidance can be downloaded on ILPA’s website. When taking into account the ILPA guidance, it is important to note that ILPA’s guidance has specifically focused its recommendations with respect to practices and disclosures in relation to the utilization of NAV Facilities for private equity strategies where the facility is structured as asset-based debt at the fund level, and as such does not cover its usage in other contexts such as closed-end real estate funds, secondaries, and private credit.

Many proponents of the use of NAV Facilities view that the concern from LPs on the use of NAV Facilities to fund distributions is somewhat unfounded when, according to estimates by the Fund Finance Association, only 20% of NAV Facilities are used for this purpose, while the remaining 80% are used to support further investment in the fund’s overall portfolio.[2] Some GPs have also expressed some concern about the recommendations for LPAC consent and enhanced disclosures, fearing that this may lead to an unwieldy and impractical process for putting such a financing in place, leading to potential delays and lost opportunities.

According to the ILPA guidance, while some GPs have already utilized NAV Facilities and have had effective communications with LPs on the matter, not all GPs have considered this process yet, which is where the ILPA guidance comes in, as it seeks to establish a standardized framework to encourage further cooperation between GPs and LPs and ensure their interests are balanced with the objectives of the fund.