Trade group hopes guidelines for PE asset-backed loans elicit transparency
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A key trade group is out with best practices for private equity firms that want to turn to NAV-based loans for early liquidity amid a dearth of exit opportunities.
Why it matters: PE firms are getting creative and increasingly turning to these credit facilities, which help them return money to limited partners or provide additional support to portfolio companies, as exits remain challenging.
- The flip side: They add even more leverage to structures that are often already highly levered.
State of play: The Institutional Limited Partners Association, which issued the guidelines, emphasizes it doesn't want to dictate when and how a PE firm should use a NAV facility — but it does want to encourage best practices around how general partners and limited partners discuss those decisions.
- Its new report includes guidelines on when and how GPs should discuss these loans with their limited partners (hint: before they get one), lists of questions they should prepare answers to, and suggested legal language for future fund agreements.
Zoom in: "[NAV loans are] a piece of leverage that increases the risk of the investment," Brian Hoehn, ILPA director of industry affairs, tells Axios about the importance for GPs to be transparent with LPs.
- There are also associated costs that come with these loans, which can ultimately impact returns.
Between the lines: PE limited partnership agreements tend to be silent on NAV loans. This has led some GPs and their lawyers to interpret this to mean they don't need have approval from limited partners to set them up, says Hoehn.
- But that's left their investors feeling blindsided and in the dark about what's going on.
Zoom out: The SEC is scrutinizing the use of the NAV loans and other fund finance instruments, according to an official's comments in May.
- The agency is looking for conflicts of interest, said Dan Faigus, SEC private funds unit senior specialized examiner, at an event, per Private Funds CFO.
- "Are LPACs being engaged, should they be engaged, does [a fee or expense] comply with the fund documents? We still see conflicts in this. There aren't theoretical risks. It is something to be mindful on the portfolio construction side," he said.
The bottom line: Where there's a trend, expect questions from those holding the purse strings and regulators.
