The Phantom Exit: NAV Lending and the Illusion of Returns

Introduction: The Exit That Never Happened

Net Asset Value (NAV) Lending refers to a form of lending that considers the NAV of the assets of a fund as collateral (or simply, lending which is secured against the underlying assets in the fund’s portfolio). Some LPs might believe that NAV Lending is a new asset class which has only emerged recently. Nonetheless, taking the NAV of various types of funds in different asset classes as collateral, banks have been lending to a variety of funds for decades. (Pemberton Asset Management)

How does it work: Liquidity, Engineered

As a financial method used by private equity funds, NAV lending is a loan which is secured by the fund’s underlying investments, including equity stakes in companies or even real assets. Lenders provide capital based on a traditional conservative loan-to-value ratio to manage risk. Typically, these loans are repaid through future asset sales or cash flows generated by the portfolio. This mechanism allows funds to hence support follow-on investments, generate liquidity and avoid selling assets at unfavourable valuations. Thus, it has now become an increasingly important tool in private markets. (International Monetary Fund)

Legitimate Case for NAV Lending: Survival Mode or a Smart Strategy?

Currently, NAV Lending has been even more pronounced in this environment, as more acute liquidity demands from sellers means they have to discount their assets even further to sell. Industry Ventures, for instance, forecasts that VC firms looking to sell early on the secondary market might be forced to sell at a 50% discount to NAV this year.

Being capable of liquidating at par, while keeping control of the equity assets, also affords borrowers with more capital to work on improving the underlying portfolio companies.

On one hand, this can mean pushing investment toward existing successful portfolio companies rather than being forced to exit them before full value creation has been realised. On the other, the capital can be used to refinance existing portfolio companies at potentially a lower cost than can be found in the public markets.

NAV lending can also provide a solution for GPs looking for ways to fund their own commitments, something increasingly salient as fund sizes grow and commitments become bigger. For example, KKR’s recent closing of its $8 billion European buyout fund – its largest to date – including $1 billion from the firm itself and employee commitments. (Moonfare)

Downsides: The Debt Behind the Curtain

Regardless of its benefits, this tool carries notable disadvantages and risks. It has the power to increase leverage at the fund level and hence can amplify losses if portfolio valuations decline. The International Monetary Fund warns that this type of financing has the potential to create ‘hidden leverage’ thus reducing transparency for investors and complicating risk assessment. Furthermore, reliance on NAV-based borrowing causes pressure on funds to delay asset sales, potentially locking in the underperforming investments. As per Fitch Ratings, declining asset values often trigger covenant breaches, forcing asset liquidation or early repayment. These factors hence make NAV lending sensitive to the market volatility and makes financial analysts question the systematic risk in private capital markets. (Preqin,Blackrock)

The Trust Problem

A significant consequence of NAV lending is relational rather than purely financial. In private equity, limited partners (LPs) provide capital, and general partners (GPs) deploy this capital responsibly on their behalf. This agreement is built on the assumption that returns are made from selling companies, not borrowed money, and what makes this concerning is that it is difficult for LP’s to distinguish between the two. Research from ILPA indicated that many LPs had no idea NAV lending was being used to bolster returns within their own funds (ILPA, 2024). This is because older LP agreements simply did not reference NAV lending, creating legal grey areas that some GPs exploited by proceeding without notifying investors or committee approval. With transparency being crucial in GP and LP relationships, opacity of this kind is problematic.

The Regulatory Awakening

Regulation has been slow to catch up. In July 2024, ILPA published the first comprehensive guidance on NAV lending (ILPA, 2024). In this report, they recommended standardised disclosures, explicit leverage limits in LP agreements, and advisory committee consent before facilities are implemented. Although this is a meaningful step, the ILPA is an industry body, not a regulatory body. Thus, its guidelines carry no legal force. In regard to the regulatory side, the SEC listed private funds’ use of debt as a crucial area of risk in its 2025 examination priorities (SEC, 2024). However, recent 2024 Supreme Court rulings have undermined the SEC’s ability to act, stripping the agency of its ability to penalise through internal proceedings and made its new rules far easier to challenge in court (SEC v. Jarkesy, 2024; Loper Bright v. Raimondo, 2024). Traditional banks have also pulled back significantly from the NAV lending market following the banking turbulence that occurred in 2023. As a result, insurance companies moved in to fill the gap. These insurers fall under state-level regulators whose frameworks were designed to oversee conventional investments, leaving them badly positioned to oversee NAV lending.

Conclusion

NAV lending doesn’t have to be inherently problematic. Used transparently, with LP consent and protective regulations, it can be an effective tool for managing liquidity across a fund’s life cycle. The difficulty lies in how it is currently being deployed. Its explosive growth, combined with frozen exits, deteriorating performance, and fragmented regulation, creates risks for LPs. The market is projected to reach upwards of $600bn by 2030 (PitchBook, 2023), yet it has never been subjected to a true stress test. Should portfolio valuations deteriorate sharply, NAV-backed loans risk amplifying losses at the worst conceivable moment. Whether the instrument proves to be a pragmatic bridge across a turbulent cycle, or a mechanism that has allowed deeper problems to accumulate unseen, is a question the industry will likely need to address.

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