Private Equity and Net Asset Value Loans – Ticking Time Bomb or Ticking All the Right Boxes?

Abstract

The private equity leveraged buyout (LBO) industry has been on the ropes in recent years, with high interest rates making acquisitions more costly, severely depressing exit values, and hampering fund-raisings. Accordingly, the industry has sought to adapt, and net asset value debt (NAV Debt) has come to the fore extolled in some quarters as being the savior of the industry. NAV Debt is borrowing by a fund backed-up by the net asset value of all the portfolio companies that it owns. NAV Debt cuts against the grain of conventional LBO mechanics by creating liabilities at the fund-level rather than at the level of individual portfolio companies. In this article, the traditional LBO model and the governance advantages that emerge therefrom are described, before discussing the way in which NAV Debt challenges the customary form. The article argues that although NAV Debt is versatile in its uses and conceptually can provide benefits to a private equity fund, it also has a darker side that undermines the carefully curated dynamics of the LBO archetype and could in certain circumstances be detrimental to LBO investors. Lenders and fund sponsors may claim that NAV Debt ticks all the right boxes, especially during a period of economic turmoil, but, in fact, its use bakes-in significant risks that could pummel final returns. Although NAV Debt is perhaps not quite a ticking time bomb, it could represent a gamble that tarnishes the returns of a generation of funds.