The Institutional Limited Partners Association (ILPA) recently issued guidance (Guidance) for limited partners (LPs) and general partners (GPs) on the use of net asset value (NAV)-based financing facilities in private equity strategies.
Background
NAV facilities (i.e., credit facilities secured by the value of a fund's investments) are increasingly used by GPs to manage debt, liquidity and support fund assets. Such facilities have been commonly used in secondaries, private credit and real estate for some time, but their prevalence in private equity strategies has increased in recent years.
The Guidance focuses on recommended practices and disclosures related to NAV facilities for private equity strategies where the facility is structured as asset-based debt at the fund level.
The Guidance intends to articulate industry expectations on how GPs engage their LPs in the use of NAV-based facilities as a liquidity and portfolio management tool. The Guidance also suggests means for improved transparency and dialogue between LPs and GPs looking to use NAV financing.
LP Concerns
ILPA published the Guidance in response to its LP members' concerns that NAV-based facilities are used in ways that leave LPs unaware of associated costs and risks. The Guidance sets out LPs' concerns regarding NAV-based facilities, including:
a) LPs often have limited insight into when NAV-based facilities are being used;
b) LPs struggle with the lack of governance related to the use of NAV-based facilities, which can drive the lack of transparency;
c) where the LPA is silent, GPs have taken inconsistent approaches to how they treat NAV-based facilities;
d) some GPs undertake NAV-based facilities without engaging or notifying LPs or the LP Advisory Committee (LPAC); and
e) LPs have observed increased use of NAV-based facilities during the more challenging fundraising environments of recent years.
The Guidance is designed to provide clarity on LPs' concerns while providing practical recommendations aimed at improving transparency and engagement between GPs and LPs.
Recommendations for Improved Transparency and LP Engagement
A key takeaway of the Guidance is the emphasis on increased transparency and disclosure.
Unless explicitly permitted by the LPA or the GP has received prior consent to utilise a NAV facility, the Guidance recommends that GPs seek LPAC consent prior to implementing a NAV facility and disclose:
a) the rationale and use of proceeds;
b) size, structure and controls (e.g., the facility size, repayment requirements, security and any financial covenants);
c) key economic terms; and
d) LP obligations, including whether any distributions funded by a NAV facility would be recallable.
The Guidance also recommends that any conflicts of interest associated with a NAV facility be brought to the LPAC.
Additionally, the Guidance recommends that GPs take specific approaches to LPAC and LP engagement, depending on the intended use of proceeds. Where a facility is to fund distributions, the Guidance recommends that LPAC consent is obtained prior to that facility being put in place, regardless of whether the GP has received prior LPAC or LPA consent to use a NAV facility generally.
Recommendations on Legal Documentation and Disclosures
In particular, the Guidance makes the following key recommendations in relation to legal documentation and disclosures:
a) where the LPA is silent on NAV financing, a GP should seek the consent of the LPAC prior to implementing any NAV financing regardless of the use of proceeds;
b) even if an LPA expressly authorises the use of NAV financing, the GP should seek LPAC approval for the use of NAV-based facilities for distributions to LPs;
c) any conflicts of interest associated with a NAV-based facility should be taken to the LPAC;
d) new LPAs should expressly establish the parameters regarding the use of NAV financings;
e) for existing funds with LPAs that are silent about NAV financing, LPs should proactively engage with their GPs to understand whether they have interpreted those LPAs as permitting NAV financing below the fund and, if so, whether that financing has been included or excluded from the LPA restrictions on fund-level borrowings; and
f) a GP that puts a NAV financing in place should provide LPs with standardised disclosures about its use of NAV-based facilities.
The Guidance sets out additional detail on each of the above recommendations, as well as sample language for new LPAs and disclosures related to the use of NAV-based facilities.
Concluding Remarks
As a result of the Guidance, we expect that GPs may experience an increase in LP queries to address NAV financing in the fund's governing documents and through regular fund reporting. In order to prepare, GPs should familiarise themselves with the ILPA's recommended disclosures and suggested diligence.
The Guidance provides general parameters for improving transparency and encouraging a dialogue between LPs and GPs around NAV-based facilities. It is hoped that the Guidance will lead to more sophisticated and productive dialogue between GPs and LPs, and a more active and liquid NAV loan market to support GPs.
The Guidance is available here.
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