The rise of NAV financings: is an equity contribution really “equity”?

Leveraged buyouts have traditionally been funded principally by debt secured against the collateral of the asset being acquired (typically borrowed by the acquisition special purpose vehicle, onward lent, and secured against the underlying collateral), combined with a sponsor equity commitment. To this, debt and equity commitment letters are commonplace within acquisition processes, and there is a clear expectation – both from sellers, and the acquisition financing provider – that the sponsor is committing true equity into the structure. However, as rising costs of capital have made investment returns more challenging, sponsors have looked to more creative ways to assist in levering their equity contribution, including by way of the incurrence of NAV financings. NAV financings used in this manner can mask the underlying nature of the equity commitment and, in a downside scenario, potentially lead to significantly more complex, and uncertain, workouts.