Private credit funds often require external financing to manage liquidity and capitalize on investment opportunities. Two common types of credit facilities are subscription line credit facilities and net asset value (NAV) based credit facilities. In this short article, we explore some of the key differences between these two much talked-about financing options.

Subscription Line Credit Facilities

Subscription line credit facilities, also known as capital call facilities or sub-lines offer liquidity to funds in the early stages of their life cycle, bridging the gap between making investments and receiving capital contributions from investors. The market for sub-lines is well developed and is estimated to be US$900 billion in size globally.

Under a sub-line, the fund borrows money from a lender that is typically a bank. The uncalled capital commitments (and related rights with respect to the fund’s investors) and the accounts into which capital contributions are paid serve as the security. Essentially, the fund is borrowing against the promise of future capital contributions from its investors. The extension of credit, which is the borrowing base for a given sub-line, is based on the lender’s assessment of the creditworthiness of that investor base.

One of the main benefits of a sub-line is that it provides immediate access to capital, allowing the investment manager to make investments without the need to make frequent capital calls. As to form, sub-line facilities are a road well-trodden, so whilst there are always nuances, terms and certainty of the security package are generally well established and predictable. These facilities are usually set up as revolving credit facilities which can be repaid periodically and then redrawn when a new investment is being made.

NAV-Based Credit Facilities

NAV-based credit facilities, NAV loans, or NAV facilities are loans extended to funds based on the value of the fund's portfolio, but it is a term used widely and can mean different things to different people. In terms of market context, if the sub-line market could be described as relatively homogenous, the market for NAV facilities, while also used for years, is more nascent and fact-specific. NAV facilities are very much a trending topic, and their status in the market more widely was cemented with the publication earlier this summer of the related ILPA Guidance for LPs and GPs.

Unlike sub-lines, which rely on uncalled capital commitments, NAV-based facilities are ultimately secured by the assets held by the fund, such as loan investments or debt instruments. The exact nature of the security package is more nuanced with key determining factors, including structure (and limitations) of the borrower and the nature of the underlying investments. It is usual for account security and rights over borrower interests in downstream entities (for example, pledges over shares or partnership interests), to form part of the security package.

Under NAV-based facilities, the fund borrows money from a lender that can be a bank or non-bank alternative lender, such as a private credit NAV lending fund. It is in the NAV lending space that we have seen the clear rise of non-bank lenders.

A key lender consideration for this type of credit facility is the accurate and regular valuation of the fund's assets, as well as the ability to dispute such valuation, which is crucial to determining the borrowing base of the fund and consequently the amount that can be borrowed.

NAV facilities are an important source of additional liquidity for funds. Another key benefit is their flexibility.

Key Takeaways

Both sub-lines and NAV-based facilities offer valuable financing options for private credit funds and come with distinct advantages and risks. Sub-lines provide short-term liquidity based on investor capital commitments, while NAV-based facilities leverage the value of the fund's assets. Sub lines are an important part of fund financing at the early stages of a fund, while it has access to significant uncalled capital. As that capital is deployed over time, a NAV facility, based on the value of the funds’ assets can become a better financing choice. Understanding these differences between the two types of facility is crucial for fund managers to choose the appropriate financing tool that aligns with their investment strategy, risk profile, and appetite.

In both cases, it is vital to ensure that the fund's documentation permits both the facility in question and the security required. And if not, if there is an ability to amend so it does so.

Watch out for our note coming soon that will put the spotlight on NAV facilities.