PRIVATE EQUITY AND NET ASSET VALUE LOANS – TICKING TIME BOMB OR TICKING ALL THE RIGHT BOXES?

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 fundraisings. Accordingly, the industry has sought to adapt, and net asset value loans (“NAV Debt”) have 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 foundational principles of private equity. The article argues that although NAV Debt is versatile in its uses and conceptually can provide benefits for 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. This Article provides a comprehensive analysis of private equity governance, LBO risk compartmentalization, private benefits of control, and performance metrics in the midst of NAV Debt. 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 undermine investor rights and could pummel final returns. Although NAV Debt is perhaps not quite a ticking time bomb, it could represent a gamble that tarnishes a generation of funds.