Net asset value lending against a portfolio with one buyer.

A facility secured on a fund's portfolio rather than on its commitments looks at the assets. The lender advances a proportion of the net asset value and takes security over the holding companies through which the fund holds, and sometimes over the fund's rights to distributions from them. The proportion depends on what the lender believes it could realise from the portfolio in its own time frame, and for an illiquid portfolio the belief is formed by asking who would buy, how fast, and at what discount to the last valuation. A portfolio of private positions across several states, each with a change-of-control consent, a co-investor's pre-emption and a regulator's approval on transfer, has an answer the lender does not like. A portfolio with a single plausible acquirer has an answer the acquirer has also worked out, and the lender prices the facility on the acquirer's arithmetic rather than the fund's.

This note sets out what net asset value lending is and when funds use it, how the lender reads a portfolio's liquidity, the single-buyer problem, the valuation as the covenant's base, what the covenants do to the register, the chain the lender secures and the enforcement it would run, the tier's leverage cap, the design decisions at formation, a comparison with the capital-call facility, a worked facility as a type, cases, what each party holds, the sequence, questions, terms and what to read.

What it is and when it is used

Net asset value lending is borrowing by a fund, or by a holding company beneath it, against the value of the portfolio, secured on the shares of the holding companies and on the distributions flowing up through them. Funds use it after the investment period, when the commitments are drawn and the capital-call facility has nothing to lend against; to fund follow-on investments, to fund a cure at a portfolio company, to bridge a distribution to holders before a sale completes, or to hold through a period when selling would be at the wrong price. It is longer in term than a capital-call facility, larger in amount, and secured on something whose value the lender has to form a view about rather than on a holder's obligation to pay.

How the lender reads liquidity

The lender asks, for each position in the portfolio, what it would take to sell it: who the buyers are, how many, whether any is already inside the position with a right of first offer or a pre-emption, what consents a sale needs from regulators, co-investors, lenders and counterparties, how long each consent takes, and what discount a buyer would require from a seller who must sell. A listed holding answers in a day. A private company with a dozen potential buyers and no consents answers in a quarter at a modest discount. A minority stake in a regulated business with a majority holder's pre-emption and a regulator's approval on transfer answers in a year, to one buyer, at that buyer's price. The lender's advance rate is the sum of those answers weighted by value, and a portfolio of the third kind has an advance rate that reflects it.

The single-buyer problem

A portfolio with a single plausible acquirer, the continuation buyer, the co-investor with the pre-emption, the majority holder with the right of first offer, the operator under whose agreement the asset runs, is worth to the lender what that acquirer would pay to a seller who must sell, which is a number the acquirer will also have worked out. The acquirer knows the lender's covenants, knows the fund's term, and knows that on a default the lender sells to the only buyer there is. The lender's enforcement therefore ends in a negotiation with that buyer, from the weakest position a seller can have, and the lender prices the facility on that negotiation's likely result. A fund that knows its portfolio has one buyer knows what its net asset value facility will cost, and the cost is the single buyer's discount, paid in the margin.

The valuation as the covenant's base

The facility's covenants are written to the valuation: a loan-to-value test on each valuation day, a cure by repayment or by contribution from the holders, and an event of default if the cure fails. The valuation is the valuer's, on the valuer's assumptions, at a date when the assets are not being sold. A valuation that falls, for any reason including a change in the valuer's assumptions, a consent that does not arrive, a comparable transaction at a lower price, produces a breach that the fund cures from commitments it may have planned to use elsewhere, or from a sale at the price the breach implies. The lender may also require its own valuation, or the right to challenge the fund's, and a lender's valuation of an illiquid portfolio is lower than the fund's by the lender's view of the single-buyer discount.

Why the lender thinks in its own time frame

A lender's time frame is the period between a default and the lender's recovery, and it is shorter than a fund's because a lender has its own funders, its own capital rules and its own reporting, each of which reads a defaulted loan as a problem that must be resolved within a period. A fund that holds an illiquid asset through a cycle is doing what the asset needs; a lender that holds a defaulted loan through a cycle is doing what its own regulator forbids. The lender therefore values the portfolio not at what it is worth to a patient holder but at what it would fetch from a seller who must sell within the lender's period, and the gap between the two numbers is the advance rate's complement. A manager who understands the lender's time frame understands why the rate is low and why a facility designed for a patient holder's portfolio is the wrong instrument for an impatient lender's recovery.

The valuer's assumptions under a facility

A valuation that serves as a covenant's base is a valuation whose assumptions the lender reads, and the lender's reading differs from the committee's. The committee reads the assumptions for whether the number is fair; the lender reads them for whether the number would hold in a forced sale. A valuation of a minority stake that assumes a sale to a willing buyer at fair value assumes away the majority holder's pre-emption, which the lender's enforcement would run into. A valuation of a regulated business that assumes the regulator's approval assumes away the year the approval takes. The lender's own valuation, or its challenge right, is the lender's correction of the committee's assumptions to the lender's time frame, and the two valuations sit side by side in the facility's covenant calculation with the lower governing.

The cure, read closely

A loan-to-value breach is cured by repaying part of the facility or by contributing capital to the holding company to restore the ratio, and the source of either is the fund's undrawn commitments, its cash, or a sale. The constitution says whether undrawn commitments may be called for the purpose, and a constitution drafted for an investment period that has ended may have no provision permitting calls for cures at all, or may permit them only within a reserved proportion. A lender reads the constitution's cure provision before it signs, and a fund whose constitution does not permit cure calls has a facility the lender prices as uncurable, which is a facility that enforces on the first breach.

The register reads the same provision from its side. A holder that subscribed to a closed-ended fund with a defined investment period did not expect a call in year seven to repay a lender, and a constitution that permits one has told the holder so in a clause the holder's counsel read at subscription or did not. The cure provision is in the memorandum as well as the constitution, because a register that learns of it at the first breach is a register that funds it under protest.

Where it surfaces

At the term sheet, when the lender's enforcement test returns an advance rate half the manager's expectation.

At the valuation day, when an assumption changes and the covenant breaks.

At the cure, when the constitution does not permit the call the cure requires.

At the tier, when a cap expressed on value falls with the value.

At the enforcement, when the only buyer names its price.

The cost of getting it wrong

A net asset value facility on an illiquid portfolio with one buyer costs, at default, the portfolio sold to that buyer at that buyer's price, which is the worst exit the fund could have had and the one the facility was meant to avoid. Before default it costs the margin the lender charged for the single-buyer risk and the cure demands the register did not expect. The alternative, an asset-level facility secured on the asset in its own state, or no leverage, costs the follow-on funded more slowly or the distribution bridged by patience. The comparison is made at formation on the enforcement test's numbers.

What the covenants do to the register

A capital-call facility asks the holders to fund calls they were going to fund anyway. A net asset value facility asks them to fund cures they were not expecting, at moments chosen by the valuation rather than by the programme. A register that subscribed to a closed-ended fund in order not to receive demands receives one when the valuation falls, and the demand is for capital to repay a lender rather than to buy an asset. The constitution says whether the fund may use undrawn commitments to cure a loan-to-value breach, and a register that reads the provision knows what the facility can ask of it; one that does not learns at the first breach.

The chain the lender secures

The lender takes security over the shares of the holding companies beneath the fund, and sometimes over the fund's receivables from them, in the jurisdictions the holding companies sit in, perfected in those registries. On enforcement it takes the holding companies, and then faces the chain beneath: the consents every sale needs from the asset states' regulators and registries, the co-investors' rights, the asset-level lenders' change-of-control clauses, and the single buyer. A lender that runs the enforcement test at the term sheet and finds that the chain cannot be sold within a year to anyone but the single buyer prices the facility as unsecured and says so in the margin. A fund that wants a better price shows the lender a chain that can be sold: no cross-guarantees, consents pre-cleared or priced, co-investors' rights carved out for a lender's enforcement, and more than one buyer.

The tier's leverage cap

The tier caps the fund's leverage, and a net asset value facility is leverage in every reading. The cap is read against the facility's size at signing and at every valuation day, because a cap expressed as a share of net asset value is a cap that falls when the valuation falls, and a facility inside the cap at signing may be outside it at the first breach. The facility's representation that the fund meets its tier covers the cap, and a fall in value can produce a tier breach and a facility breach on the same day.

The design decisions at formation

A fund that intends to use portfolio leverage decides at formation what the facility may fund, what proportion of commitments is reserved for cures, what the valuation provisions say about frequency and about the valuer's assumptions, whether the constitution permits the fund to use undrawn commitments for cures, and what the chain beneath must look like for a lender to price it as secured. It also runs the lender's enforcement against the chain: if the lender took the holding companies, which consents would it need to sell them, how long, to whom. A fund that did not decide those at formation decides them at the term sheet, with the lender's counsel holding the pen.

By feature · by facility	Capital-call facility	Net asset value facility
Secured on	The undrawn commitments and the call right	The holding companies' shares and distributions
Lender's credit	The holders	The portfolio's liquidity
When used	During the investment period	After it
Term	Short; revolving; clean-down	Longer; amortising or bullet
Covenants	Borrowing base; clean-down; tier	Loan-to-value on valuation; cure; tier's cap
What it asks the register	Calls they would fund anyway	Cures they did not expect
Enforcement	Calls in the manager's name; sweep of the account	Sale of the holding companies through the chain's consents to the buyers there are
Pricing driver	The register's grades	The single-buyer discount and the consents' time

A timeline, as a type

Year one: the fund is formed with a constitution that permits calls for cures within a reserved proportion, a valuation provision with assumptions disclosed, and a chain designed to be sold. Year four: the investment period ends; the fund seeks a net asset value facility for a follow-on. The enforcement test is run before the term sheet; the lender's advance rate reflects two positions with single buyers; the fund accepts it with the committee's understanding. Year five: a consent at one position is delayed; the valuer's assumption changes; the covenant breaks by a small margin; the fund cures from the reserved commitments under the constitution's provision; the register funds the call it was told about at subscription. Year six: the position's consent arrives; the valuation recovers; the facility is repaid from the sale of the two liquid positions; the single-buyer positions are sold on the fund's own timetable to buyers the fund found, not the lender.

The structure paper's page

The structure paper's portfolio leverage page carries: the decision at formation to permit or exclude net asset value lending; the constitution's cure provision and the reserved proportion; the valuation provisions read as a covenant base; the chain's design for sale, position by position, with the buyers, the consents and the time; the tier's cap at signing and at a stressed value; the lender's likely advance rate from the enforcement test; and the committee's briefing on what a breach asks. The page is prepared before the term sheet, and a lender that receives it reads a fund that understands its own question.

The asset-level alternative

Where the portfolio is one asset, or a few with one lender each, the cleaner leverage is at the asset level: a facility secured on the asset in its own state, with that state's enforcement route, priced on the asset's own liquidity and not on a sale of a holding company to the one buyer above. An asset-level lender's recovery is the asset, which has a market of its own kind; a fund-level lender's recovery is the holding company, which has a market of one. A fund with a single-buyer portfolio that wants leverage takes it where the asset is, and reads the intercreditor between the asset lender and any fund-level facility so that the two do not enforce against each other.

The continuation vehicle as the lender's exit

A fund whose net asset value facility cannot be repaid from sales often repays it from a continuation vehicle: the portfolio is transferred to a new fund under the same manager, the new fund's capital repays the old facility, and the rolling holders carry the positions forward. The lender reads the continuation as its exit and may require it, or a sale process, as a remedy on a breach. The continuation carries the conflict it always carries, with the addition that the transfer price now has a lender's repayment inside it, and the rolling holders' committee reads the price knowing that the lender's claim sets its floor. A fund that took the facility with the continuation in view has told its register so; one that did not has a continuation forced by a covenant rather than chosen by a strategy.

The distributions the lender takes

A net asset value facility usually takes security over, or a covenant on, the distributions flowing up from the holding companies, so that a sale's proceeds repay the facility before they reach the fund's own waterfall. The waterfall therefore runs after the lender, and the manager's share and the holders' distributions are calculated on what the lender leaves. A register that expected a distribution from a sale and received the lender's repayment instead has read a waterfall the facility rewrote, and the memorandum describes the facility's claim on proceeds where the constitution permits one.

Reading the facility with the co-investors

A co-investor holding beside the fund in a position has rights the lender's enforcement runs into: a pre-emption on the fund's stake, a tag-along on a sale, a consent to a change of control. A lender that enforces its share security over the holding company and then sells the position finds the co-investor's pre-emption first, and the co-investor is the single buyer. The co-investment agreement is read at the term sheet for a lender's enforcement carve-out: a provision that a sale by a secured lender enforcing its security does not trigger the pre-emption, or triggers it at a price the lender can accept. A co-investor that will not give the carve-out has told the lender who the buyer is, and the lender prices accordingly.

A facility, as a type

A fund after its investment period holds five positions: two private companies with several potential buyers and no consents, two minority stakes with majority holders' pre-emptions, and one regulated business with a regulator's approval on transfer. It seeks a net asset value facility to fund a follow-on. The lender's counsel runs the enforcement test: the first two positions sell in a quarter at a modest discount; the minority stakes sell to the majority holders at their price in a year; the regulated business sells to whomever the regulator approves, in a year. The advance rate is weighted accordingly and is low. The fund's constitution permits undrawn commitments to cure a breach; the valuation is quarterly with the assumptions disclosed; the tier's cap is read at the facility's size and at a stressed valuation. The facility is signed at a margin that reflects the two minority stakes, and the fund's committee is told what the first breach would ask of the register.

Four cases, as types

A fund with a portfolio of minority stakes and a regulated business takes a net asset value facility sized on the fund's own valuation, without an enforcement test. A consent at the regulated business is delayed; the valuer's assumption about it changes; the valuation falls; the loan-to-value covenant breaks; the cure requires a call the constitution does not permit for that purpose; the lender enforces, takes the holding companies, and sells the minority stakes to the majority holders at the price the majority holders name.

A fund's facility is inside the tier's leverage cap at signing, with the cap expressed as a share of net asset value. The valuation falls by a fifth; the facility is now outside the cap; the fund is in breach of its tier and of the facility's representation on the same valuation day, and the regulator's question arrives with the lender's.

A fund designs its chain for the lender: no cross-guarantees, co-investors' rights carved out for a lender's enforcement, consents priced at entry, and two of its five positions with several buyers. The lender's enforcement test finds a chain that can be sold within a year to more than one buyer for most of its value, and prices the facility as secured.

A fund with a single asset and a single buyer, the operator under whose agreement the asset runs, takes a net asset value facility. The operator knows the facility's covenants. The valuation falls; the lender enforces; the operator buys at the operator's price; the facility was, in the end, a sale of the asset to the operator on terms the operator chose and the lender accepted.

What each party holds

The manager holds the design decisions at formation, the constitution's cure provisions, the chain designed to be sold, and the committee's understanding of what a breach asks.

The lender holds the enforcement test, the advance rate, the loan-to-value covenant and its own view of the valuation.

The valuer holds the number and its assumptions, which are the covenant's base.

Counsel in each holding jurisdiction holds the perfection of the share security; counsel in each asset state holds the consents on a sale.

The co-investors and the majority holders hold their rights, which the enforcement runs into.

The register holds the cure it may be asked for and the constitution's provision on it.

The sequence

1. The decision to use portfolio leverage is taken at formation, with the constitution's cure provisions and the valuation provisions drafted to it.
2. The chain beneath is designed to be sold: no cross-guarantees, co-investors' rights carved out for a lender's enforcement, consents priced at entry.
3. The enforcement test is run before the term sheet: for each position, the buyers, the consents, the time and the discount.
4. The tier's leverage cap is read at the facility's size and at a stressed valuation.
5. The facility's covenants are read against the constitution and the valuation provisions.
6. The committee is told what the first breach would ask of the register.

Questions a manager asks

Why is the advance rate so low. Because the lender's enforcement ends in a sale of illiquid positions, through consents, to the buyers there are, in its own time frame, and the rate is the lender's view of that sale.

Can the facility be sized on the fund's valuation. The lender applies its own view to the fund's valuation, and an illiquid portfolio's valuation is the starting point of the lender's discount, not its end.

What does a breach cost. A cure from commitments, if the constitution permits and the holders fund, or a sale at the price the breach implies; and a tier question if the cap is expressed on value.

Does the facility reach the holders. Not directly; it reaches their undrawn commitments if the constitution lets the fund call them for cures, and the register reads that provision.

Is there a better structure for a single-asset fund. A facility at the asset level, secured on the asset in its own state, with the asset's own lender's route, is priced on the asset rather than on a sale of the holding company to the one buyer; the fund-level facility is the wrong instrument for one asset.

What does the lender's enforcement test need from the fund. The chain, the consents on each position, the co-investors' documents, the asset-level facilities' change-of-control clauses, and the fund's own honest list of buyers.

Terms used

Net asset value facility: borrowing secured on the portfolio's value and the holding companies' shares, after the investment period.

Loan-to-value covenant: the test of the facility against the valuation at each valuation day.

Cure: repayment or contribution to restore the covenant after a breach.

Enforcement test: the lender's reading of what it could sell, to whom, through which consents, in what time.

Single-buyer discount: the price a sole plausible acquirer would pay a seller who must sell.

Leverage cap: the tier's limit on the fund's borrowing, read at signing and at each valuation.

What to read

The facility's security, covenants, valuation provisions and events of default; the constitution's borrowing, cure and valuation provisions; the tier's leverage rules; each position's consents, pre-emptions and change-of-control clauses; the holding jurisdictions' security registries. On this site, the financing and exit design rooms under Structures and the worked structure on a narrow exit.