Institutional Investor Newsletter

Overview and structure

Net asset value (NAV) facilities – which are credit facilities secured by the value of a fund’s investments – are increasingly used by sponsors to support existing investments and generate distributions. The market for NAV facilities is currently $100 billion and is expected to grow to $600 billion by 2030.[1] A NAV facility is typically held in a special-purpose vehicle (SPV) below the fund. This SPV owns the equity of a separate SPV – which owns the fund’s investments (or some of the investments) as collateral. These fund investments are often cross-collateralized to secure the loan.

Business rationale, risks, and costs

A sponsor may use a NAV facility to provide capital to support the fund’s portfolio. This capital may be allocated to make new investments or follow-on investments, even if the fund does not have sufficient reserves or the ability to recycle capital. However, this use may change the expected risk profile of the fund for investors by subjecting the fund to additional leverage. Risk is further increased from cross-collateralization of the facility across the fund’s investments – and a general partner may be incentivized to accept this additional risk to increase its carry from the fund.

Sponsors also use NAV facilities to generate distributions for investors. While this liquidity may be beneficial for investors, these distributions are frequently recallable, which may impact a limited partner (LP)’s ability to deploy such amounts for other purposes. In addition, such use could significantly impact the internal rate of return (IRR) and distributions to paid-in capital (DPI). This may further affect LPs’ ability to review the fund’s performance, as LPs may lack visibility into the use of such facilities to “artificially” create cash flow.

Finally, the cost of NAV facilities could be significant, as interest rates on such facilities are often higher than those for subscription facilities.

Trends in sponsor approaches

Despite the increased use in the market, sponsors have generally not been proactive in disclosing the use of NAV facilities to investors. Until recent years, limited partnership agreements (LPAs) did not contemplate NAV facilities, and many newer LPAs still do not. Many sponsors interpret the borrowing provisions in such older LPAs to permit NAV facilities, particularly when the LPA includes limitations on “borrowing” without specifying the type of borrowing (eg, a subscription facility).

In addition, many sponsors take the position that, because a NAV facility is housed in an SPV below a fund, such facilities do not fall within the scope of the fund’s borrowing limitations, meaning that any borrowing caps also do not apply to such facilities. This interpretation is being made despite the fact that NAV facilities were not contemplated by investors or discussed in due diligence materials reviewed by investors. In contrast, real estate fund LPAs typically include leverage restrictions for borrowing below the fund – such terms and related risks are disclosed and negotiated at the outset of the investments in the related fund.

Finally, even if a sponsor were to request limited partner advisory committee (LPAC) approval for NAV borrowing, the sponsor may often ask for blanket approval to use NAV facilities without seeking consent for a specific facility and its terms.

Best practices

It is clear that sponsors have already put NAV facilities to good use (often while disclosing such use to LPs). This practice is likely to continue in the coming years – and NAV facilities have the potential to materially impact an investor’s funds and returns. Investors are encouraged to conduct due diligence on a sponsor’s intended use of NAV facilities when investing in a fund and may consider negotiating reasonable limitations around their use in the fund’s LPA.

Ideally, fund LPAs would clearly state whether NAV facilities are permitted. The LPA may include (i) the fund level leverage restrictions that cover borrowing under NAV facilities when the proceeds are used to support portfolio investments and (ii) whether a sponsor should be required to seek consent from the LPAC if the facility will be utilized to make distributions.

Even if an LPA does not address NAV facilities, sponsors are encouraged to provide LPs with consistent reporting on any existing NAV facilities, including the rationale for and the terms of such facility, so that LPs have the information to evaluate the impact of borrowing on their investments in the fund.

When the Institutional Limited Partners Association (ILPA) publishes its latest guidance regarding NAV facilities, we expect that this guidance will expand upon the issues and practices discussed in this newsletter.

Please contact the authors with questions regarding NAV facilities as they arise in connection with the private fund investment activities of your organizations.


[1] Fund finance association.

Featured lawyer spotlight:

Matthew Cohen
Of Counsel

1. Describe your practice. I focus on representing sovereign wealth funds and other institutional investors in their private investments – whether in funds, co-investments, GP stakes, managed accounts, or other alternative equity financing transactions. I also advise on respective investment operations. I spent two years as a secondee to a Middle East sovereign wealth fund, sitting on its Investment Committee. My aim is to offer clients insight on their investment-related diligence, analysis, risk management, and execution processes.

2. Describe how you got connected with the DLA Piper team. Skye Smith, a partner in DLA Piper’s Dallas office, introduced me to the Investment Funds team. I have known Skye for almost ten years, as we had worked together at a previous firm. I had also worked opposite Richard Cardillo, a partner in DLA Piper’s Austin office, while I was on the GP side of a transaction with a prior firm. I’ve been impressed by the pragmatic approach that the DLA Piper team takes when representing our Institutional Investor clients.

3. GP stake deals are on the rise for institutional investors. How have you seen clients approach this trend? Our clients see GP stakes as a means to further entrench themselves with their managers, while simultaneously diversifying their portfolio. Clients are excited by the potential, supplemental revenue and transparency into the operations of their preferred sponsors. I enjoy helping clients negotiate the structuring and conflicts issues that are inherent in these transactions.

4. How do you approach a new client, investment, or transaction? What is your philosophy, and how does that translate to your practice? With each new client, I do a deep dive on its issue sensitivities, the client’s process, the client’s personalities, and the client’s history with the counterparty and the firm. I take a holistic approach to addressing a client’s needs for a deal and helping the client navigate its operations and relationships. This philosophy allows me to be a creative and collaborative partner for the client.

5. Where are you originally from, and what is your favorite travel experience? While I was not born in Atlanta, I was raised there and would consider myself an “ATLien.” My favorite travel experience was when I spent three weeks in Hawaii with my fiancée Nancy-Ann, and we had a personal tour of Pearl Harbor with an active-duty Navy officer.