NAV loans are a poor answer to private equity’s struggles

dane_mark, iStock

Net asset value (NAV) financing, debt raised by private equity funds secured against whole portfolios of companies, has grown fast in recent years, as managers of those funds struggle to sell companies at higher prices than they paid for them.

The addition of yet more borrowing onto a business already built on high leverage is a growing worry for investors in PE funds and for regulators.

PE managers now have to hold companies for longer than they used to: maybe six to seven years rather than the three to five they promised investors when they raised funds. Like all speculators, they tend to characterize their bad trades as strategic long-term holds. But the neutral rate of interest is not going back to the lows of the past 15 years. Higher-for-longer rates depress the discounted value today of future cash flows from portfolio companies. So, the prices that trade buyers or IPO investors will pay also remain low.

And PE funds exist to buy when companies are cheap, not to sell.

Beyond buying companies when public equity investors attach sunken valuations to them and selling them back when stock markets soar, PE funds are in another business: that of raising funds from limited partners and charging them 2% to hold their cash.