The private equity industry is currently facing significant challenges, including a substantial backlog of unsold companies. Between 2022 and 2024, rising interest rates combined with global economic and geopolitical uncertainty have contributed to a subdued exit environment, making it harder for PE funds to sell portfolio companies and return capital to their investors, known as Limited Partners (LPs). This has resulted in capital remaining tied up in aging portfolios, causing extended waiting periods for returns.
In response to these conditions, a particular form of fund-level financing known as Net Asset Value (NAV) lending has gained traction. This debt instrument, secured against the entire portfolio of a fund, marks a philosophical shift in how risk is managed within private equity.
NAV lending is a type of financing used primarily by private equity funds, where the loan is secured against the current net asset value (NAV) of the fund’s entire portfolio of investments. NAV loans use the combined market value of the companies within the portfolio as collateral. This allows funds, especially in their later stages (compared to the initial stages where the funds have access to LP capital commitments and other initial financing and credit lines), to access liquidity without having to sell assets at discounted prices in challenging market conditions. Lenders typically provide these loans at conservative loan-to-value ratios, commonly between 10% and 30%, to mitigate risk. The proceeds from NAV lending can be used to support follow-on investments, refinance existing debts, or provide distributions to limited partners. Despite its benefits, NAV lending introduces new structural risks and requires careful management to balance potential returns with risk exposure.
The Fund Finance Association estimated this market at around $100 billion in 2022, with projections indicating significant growth towards $700 billion by 2030 as it reshapes traditional fund financing approaches.
This article distills the most surprising and impactful takeaways about the new force reshaping private markets.
Updating the Old Private Equity Playbook
For decades, the traditional leveraged buyout (LBO) model operated under two fundamental rules designed to contain risk and protect investors.
Rule 1: No long-term debt at the fund level. The fund itself was kept “clean” of liabilities. Its sole purpose was to receive investor capital and distribute the proceeds from successful company sales.
Rule 2: Each company is an insulated silo. Every company that the fund owned was held in a separate, ring-fenced structure. This ensured that a disaster in one company would not impact the other portfolio companies.
The infamous Toys “R” Us bankruptcy serves as a powerful example. A consortium of PE firms acquired the company in a 2005 LBO, but the investment ultimately proved disastrous, leading to a $1.3 billion loss for the KKR Millennium Fund. However, because the debt was siloed at the Toys “R” Us level, the fund’s other healthy investments, such as Sunguard and HCA, were completely insulated and unaffected by the failure. In fact, despite the heavy loss on Toys “R” Us, the KKR Millennium Fund still delivered an overall IRR of over 16% to its investors, powerfully demonstrating the resilience of the traditional risk-containment model. The silo worked exactly as designed.
NAV lending takes a sledgehammer to this carefully curated structure. It introduces long-term debt at the fund level, secured against the entire portfolio. The primary consequence of breaking these rules is contagion risk. With NAV lending, the failure or poor performance of a single company can now jeopardize the entire fund. NAV loans are often secured by multiple portfolio assets and if one fails, lenders may access or accelerate claims on proceeds from others, impacting even healthy investments and reducing LP recoveries. This breaks the traditional “silo” structure of private equity, creating portfolio cross-contamination risk.
It’s Controversial, But the World’s Biggest Investors Are Piling In
Historically, NAV lending was the domain of “backwater operators” or “smaller private equity sponsors owning distressed assets” who lacked access to traditional financing. This perception is rapidly changing, creating a paradox: while the tool remains controversial for fundamentally altering risk, some of the world’s most sophisticated institutional investors are now embracing it.
Major sovereign wealth funds, most notably the Abu Dhabi Investment Authority (ADIA), are anchoring massive NAV financing strategies. ADIA is the anchor investor for Pemberton Asset Management’s strategy of at least $1 billion. This backing provides a powerful stamp of approval that is mainstreaming the practice. “This anchor commitment from ADIA is an indicator that NAV financing is becoming a standalone institutional asset class.” – Thomas Doyle, Partner at Pemberton.
The involvement of players like ADIA signals a tectonic shift. A tool once relegated to the fringes is now becoming a key part of the institutional financing toolkit.
It’s Both a Lifeline for Growth and a Contentious Cash-Out Machine
NAV credit can be categorized into three primary uses, each with different strategic goals and levels of controversy.
- Offensive NAV Credit (Opportunistic): This is used to fund new, value-creating investments. A common use is financing “bolt-on acquisitions,” where an existing portfolio company acquires a smaller competitor. It can also be used to refinance existing portfolio company debt at a lower cost than would be available to the single asset.
- Defensive NAV Credit (Reactionary): This is a reactive measure used to “buttress underperforming assets” or rescue struggling portfolio companies. It provides a capital injection to help a company navigate a difficult period and prevent a default on its original acquisition debt.
- Liquidity NAV Credit (Controversial): This is used purely to make cash distributions to investors (LPs) when the fund cannot generate liquidity by selling assets. This is the most contentious use because it creates synthetic distributions. Critics argue it can be used to artificially “game distributions to paid-in capital (DPI)”, a key performance metric, just before the GP begins raising its next fund. This creates the appearance of a successful exit without the underlying value creation of an actual sale.
While NAV lending is often pitched as a tool for value creation, its use as a financial engineering tool to return cash is what raises the most red flags.
It Creates a Hidden Conflict Between Managers and Investors
While Net Asset Value (NAV) lending has become a popular tool for unlocking liquidity in private equity portfolios, it introduces several risks that challenge the traditional alignment between General Partners (GPs) and Limited Partners (LPs). Critics often call it “leverage on leverage,” as it layers fund-level debt over already leveraged portfolio companies.
Misalignment of Interests
NAV lending can distort incentives and performance metrics. Distributions funded by NAV loans artificially inflate the Distributed to Paid-In Capital (DPI) ratio, allowing GPs to trigger carried interest payments much earlier than if profits were realized through actual exits. This means GPs can get paid based on borrowed money rather than genuine value creation.
Fundraising Incentives
Private equity operates on a continuous cycle where GPs need to return capital from older funds so LPs can invest in new ones. When exit markets slow, NAV facilities provide liquidity to keep this cycle moving. However, this can lead to short-term decision-making focused on fundraising optics rather than long-term returns.
Contagion Risk
Because NAV loans are typically cross-collateralized, a decline in a few portfolio companies can threaten the entire fund. For example, if a $5 billion fund takes a $1 billion NAV loan and the portfolio value falls to $4.1 billion, the loan-to-value ratio may breach covenants, forcing asset sales at unfavorable prices and spreading localized losses across the portfolio.
Conflicts of Interest and Hidden Leverage
NAV credit can be used for purposes that benefit the GP more than the LP, such as accelerating carried interest payments or extending a fund’s life to earn more management fees. In addition, layering fund-level debt over company-level borrowing obscures the true amount of leverage and can make performance appear stronger than it is.
Loss of Structural Benefits
Because the debt sits at the fund level, interest payments cannot be deducted from portfolio company profits, reducing the tax efficiency of the structure. It can also weaken governance discipline, as fund-level leverage dilutes the accountability mechanisms built into traditional leveraged buyouts.
NAV Lending: A Maturing Force in Private Equity
NAV lending has moved from the margins to the mainstream of private equity, with heavyweight institutions like Pemberton and ADIA launching dedicated NAV financing platforms. What began as a temporary fix during periods of illiquidity and high interest rates is now being used more strategically to support follow-on investments, stabilize portfolios, and bridge slower exit environments. For many funds, NAV credit is a short-term bet that improving market conditions and valuations will more than offset the cost of debt. If recovery plays out as expected, these facilities could help unlock meaningful value and preserve long-term returns. If not, the high interest burden and covenant risks could weigh on outcomes. Still, the industry is adapting fast. Managers are learning to use NAV financing with more discipline, while investors are demanding stronger oversight and transparency. NAV financing may never become a permanent fixture of the private equity model, but it will continue to evolve as a smart, situational tool. Used thoughtfully, it can strengthen portfolios and smooth out market cycles rather than destabilize them. The next chapter of NAV lending is likely to be one of refinement, not retreat.
