11th August 2021
We’ve put together a simple explanation of portfolio finance, first we look at what it is and then in particular who uses it and what for. If you’d prefer to listen to someone explain it then watch our video using the button below.
What is it?
Portfolio financing – also called NAV-based financing – is capital provided by a lender to a fund or specific vehicle owning a diversified underlying portfolio of companies.
How does it work?
The financing is repaid from cashflows from the underlying diversified portfolio, for example the sale of a company. The lender receives seniority over distributions until repaid. They are the last capital in, and the first capital out, from the portfolio.
In return, the borrower receives flexible, non-dilutive capital and retains full ownership of the assets and the potential upside. This creates great alignment between lender and borrower.
As a result, portfolio financing is being adopted by leading players across the private equity industry. Fund portfolios, management companies, and investors are using it as a strategic tool for value creation: by accelerating liquidity or increasing capital. Let’s take a look at each of these in turn.
Fund Portfolio
Managers or sponsors of existing funds can use portfolio financing to increase investment capacity to support existing portfolios; for instance, to finance accretive add-on acquisitions. They can also use it to accelerate liquidity to their investors and help optimise fund performance. It is a flexible alternative to individual company leverage or traditional liquidity events such as IPOs or M&A.
Management companies
Managers looking to increase their GP commitment, optimize their balance sheet, seed a new strategy or finance succession planning can use portfolio financing. Often, it is an alternative to selling a minority equity stake. Finance is provided against the management company’s economic streams, including GP commitments, carried interest and management fees.
Investors
Limited Partners in high quality portfolios use portfolio financing as an alternative to a secondary sale. Typically, they are raising capital to generate early liquidity, to fund future commitments, or to rebalance their portfolio. The investor receives capital upfront, avoids a discount to NAV, and retains access to portfolio upside.
Part of the private equity managers toolkit
As we can see, portfolio financing is a flexible solution with a broad range of applications across the private equity landscape. Now that it’s becoming increasingly understood and accepted, it will become a standard feature of the market.