USA Trends and Developments Contributed by: Bill Sturman, Matthew Holt, Steven Starr and Cliff Cone, Clifford Chance
Collateral and borrowing base The primary collateral for NAV financings is the fund’s portfolio of investments, which can include equity stakes in portfolio companies, real estate holdings, or other assets depending on the fund’s strategy. Lenders have optionality in how aggressive they want to be in terms of their security interest in the fund assets. Previ - ously, NAV facilities often required more onerous collateral packages, including direct pledges of investments, equity in portfolio companies and intermediate holdings companies, and distribu - tion proceeds from investments. Recent trends show a shift towards more lenient terms, with lenders accepting a lighter collateral footprint and more flexible structures, including, in some cases, only a security interest in the cash flows generated by the investments or, in some cases (such as preferred equity NAV financings), no collateral at all. Amortisation and cash sweep Because the primary source of repayment for a NAV facility are the assets of the fund, almost all NAV facilities require that, if such assets are sold or otherwise disposed of, the proceeds of that disposition are used to pay down the facility. As market competition has increased, some lenders have loosened these cash sweep requirements. In some cases, lenders have agreed to, among other things: • looser financial thresholds before cash sweeps are triggered; • reduced frequency of cash sweeps (for exam - ple, on a monthly or quarterly basis rather than immediately upon receipt of proceeds); • additional carve-outs of certain types of income or proceeds from the cash sweep; • longer cure periods to address any breaches of financial covenants before cash sweeps are triggered; and
• a right for the borrower to cure financial cov - enants by contributing equity to the fund in order to avoid triggering a mandatory prepay - ment or cash sweep. PIK (pay-in-kind) interest The option for borrowers to pay interest “in kind” (ie, to add the interest to the principal balance rather than paying it when due in cash) has also become more common in NAV credit facilities over the past year. This option is attractive for borrowers because it enables them to use the entirety of the amount borrowed under the NAV facility instead of holding back some cash in reserve to make interest payments. While lend - ers sometimes require fund borrowers to use their initial borrowing under a NAV term loan to fund an interest reserve account (and require such account to be replenished from time to time), lenders are increasingly open to reducing the amount of cash that must be kept in such account or giving up this requirement entirely. Control of cash flows Most NAV facilities capture the flow of cash from the underlying fund assets through a combina - tion of a security interest, deposit account con - trol agreement, and covenants relating to invest - ment proceeds. NAV lenders are highly focused on the flow of cash from investments because that cash is their ultimate source of repayment. Accordingly, NAV facilities typically include cov - enants requiring that all proceeds from fund investments (or, in some cases, only proceeds from “eligible investments”) are deposited in a cash collateral account over which the bank has a perfected security interest. As the NAV lending space has become more competitive, lenders have loosened the level of control that they require with respect to these cash flows. Recently, more lenders have allowed
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