A NAV loan is a loan to a fund secured by the value of its investments, its net asset value (NAV). Where a subscription line (lesson 5.1) looks to LPs' uncalled commitments, a NAV lender looks to the portfolio itself: the companies a buyout fund owns, the loans a credit fund holds, or the fund interests a secondaries fund has bought.
GPs commonly use NAV loans later in a fund's life, and they raise questions that LPs, consultants and regulators watch closely. Lenders need to size and monitor these loans. LP-side analysts need to understand why their fund has borrowed against its portfolio and what that does to their risk and returns. PC303 3.2 covers how NAV is calculated; this lesson is about borrowing against it.
When and why funds use NAV loans
Subscription lines work best early, when a fund has plenty of uncalled commitments. By the later years, most commitments have been called and the fund's value sits in its investments. A NAV loan lets the fund borrow against that value. GPs commonly use one to:
- Support existing portfolio companies, for example with follow-on investments or add-on acquisitions, when the fund has little capital left to call.
- Provide liquidity while waiting for exits, for example to cover fund expenses or a portfolio company's short-term needs.
- Pay distributions to LPs before the underlying investments are sold.
- Manage timing at the end of a fund's life, for example to give the GP more time to sell assets at better prices.
How NAV loans are structured
The key measure is loan-to-value (LTV), the loan divided by the value of the portfolio securing it. It works just like the property LTV in lesson 4.1, except that the "property" is a whole portfolio of fund investments.
Common features include:
- An LTV limit. The loan agreement sets a maximum LTV. If NAV falls far enough that LTV passes the limit, the fund usually has to fix it, for example by repaying part of the loan, adding assets or diverting cash from exits to the lender.
- Cash sweeps. A share of the proceeds from exits commonly goes to pay down the loan, sometimes rising as LTV rises.
- Security. The lender usually takes security over the fund's holdings, often over the entities through which it owns its investments rather than over the portfolio companies' own assets, and over accounts that receive exit proceeds.
- Diversification tests. Lenders care how many investments support the loan. A loan against ten companies is safer than one against three, because one failure hurts less.
NAV lenders are structurally behind every portfolio company's own lenders. A buyout fund's portfolio companies each have their own debt, and the NAV lender is paid only from the fund's equity in those companies, after that debt. This is the structural subordination you met in lesson 2.2. It's one reason NAV loans are commonly sized at low LTVs.
The worked NAV loan
The following example is illustrative. A fictional buyout fund in its sixth year has a portfolio with a NAV of $1.2bn. It takes a NAV loan at a 15% LTV:
$1.2bn × 15% = $180m
Now suppose a downturn hits and the portfolio's NAV falls 25%, to $900m. The loan doesn't shrink. It's still $180m:
| At closing | After a 25% fall in NAV | |
|---|---|---|
| Portfolio NAV | $1,200m | $900m |
| Loan | $180m | $180m |
| LTV | 15% | 20% |
LTV has risen from 15% to $180m ÷ $900m = 20%. If the loan's LTV limit is 20% or lower, the fund may now be in breach, and it must repay part of the loan, pledge more assets or send more exit proceeds to the lender. For example, to bring LTV back to 15% at a $900m NAV, the loan would need to fall to $135m, so the fund would have to repay $45m.
Notice two things. First, a 25% fall in NAV raised the LTV by a third, from 15% to 20%, because the loan stays fixed while the value moves. Second, the fund's cash needs rise just when things are hardest: in a downturn, exits are slow and NAVs are falling, so finding $45m may mean selling assets at a bad time. That's the core risk for both the lender and the LPs.
For the lender, the equity below it is the cushion, just as in the Northfield Components waterfall (PC101 3.1). At a 15% LTV, the portfolio would have to lose 85% of its value before the lender's principal is at risk, ignoring interest and costs. That's why NAV lenders commonly focus less on whether the portfolio falls and more on how much, and on how quickly they can be repaid from exits.
Why LPs and regulators ask questions
NAV loans can be useful, but their use to pay distributions has drawn the most attention. Borrowing against the portfolio to return cash to LPs:
- Raises DPI and IRR in the short run, because LPs get cash back sooner. As lesson 5.1 showed for sub lines, earlier cash lifts IRR even when total profit falls.
- Lowers the multiple, because the fund pays interest on the loan, which comes out of the LPs' eventual proceeds.
- Adds risk to the remaining portfolio, since the loan must be repaid before LPs receive later exit proceeds. If the portfolio underperforms, LPs may have taken cash early only to see later distributions shrink by more.
- Can affect the GP's economics. Earlier distributions can help a fund reach its preferred return and start paying carried interest sooner (PC303 3.3), which is why LPs look closely at whether the loan serves them or the GP.
LP-side analysts commonly ask whether the fund's documents allow NAV borrowing, what it's being used for, what the LTV and cure terms are, and how returns would look without it. Industry groups representing LPs have published guidance asking for clearer disclosure, and regulators in some markets have asked how fund-level borrowing is used and reported.
Other uses draw fewer questions. Funding a follow-on investment that protects the value of an existing company is easier to justify than borrowing simply to send cash back early.
Key terms
- NAV loan: A loan to a fund secured by the value of its investment portfolio.
- Net asset value (NAV): The value of a fund's investments and other assets, less its liabilities.
- Loan-to-value (LTV): The loan divided by the value of the assets securing it.
- LTV limit: The maximum LTV the loan agreement allows before the fund must act.
- Cash sweep: A requirement that part of exit proceeds goes to repay the loan.
- Cure: Action the fund takes to bring a breached test back within its limit, such as repaying part of the loan.
Key takeaways
- A NAV loan is secured by the fund's portfolio, not by LPs' uncalled commitments, so it's used later in a fund's life.
- At a 15% LTV, a $1.2bn NAV supports a $180m loan; if NAV falls 25% to $900m, LTV rises to 20%, which may breach the limit.
- The lender sits behind every portfolio company's own debt, so NAV loans are commonly sized at low LTVs.
- Borrowing to pay distributions can raise DPI and IRR while lowering the multiple and adding risk, which is why LPs ask questions.
This lesson is for educational purposes only and is not investment advice.