The secondaries market has grown from strength to strength in recent years; the transaction volume of $165 billion in 2024 represented a 40% increase over the prior year.While recent market turmoil may make the short-term outlook hard to predict, over the long term, both transaction volume and fundraising are expected to increase.This growth has been accompanied by a greater use of leverage by secondaries funds.Indeed, the slowdown in M&A activity and related reduction of distributions from the underlying portfolio is likely to spur funds to incur more leverage, including to cover liquidity needs and to return capital to investors. While the nuts and bolts of a secondaries net asset value (NAV) financing are not new, the growth in volume has attracted new entrants and resulted in innovation in the market.
Deferral Security and NAV Financings
Liquidity needs are not the only factor driving the significant growth in the secondaries market—plenty of sponsors engage in secondary transactions for purposes of, among other things, rebalancing their portfolio allocations or de-risking their fund. As a result, sellers in recent deals have been more willing to defer a significant portion (50% or more) of the purchase price in exchange for a meaningfully higher headline price (3–4% in recent experience) and a more robust guarantee and security package, which may include parent guarantees, pledges of equity interests in the SPV holding the portfolio, pledges of bank accounts into which distributions from the portfolio will flow and/or a pledge of the unfunded capital commitments of the investors.Buyers, on the other hand, often want to obtain a NAV facility whose proceeds can be utilized to make the closing date purchase price payments or to return capital more quickly to investors.
The competing obligations—deferral owed to sellers and NAV loans to lenders of the buyer—can create a complicated structuring and deal dynamic as sellers push for deferral security to come ahead and buyers push for NAV loans to come ahead to preserve maximum financing flexibility.Often, sellers are willing to agree to have the NAV facility come ahead in respect of the underlying portfolio investments so long as the buyers have provided guarantees from well-capitalized entities above the NAV structure.
Insurance Investors
Another notable trend is the prevalence of insurance investors in NAV financings.The terms of these facilities often blur the line between a secondaries NAV financing and a securitization or collateralized fund obligation (CFO) transaction.Key features of insurance financings include the following:
- Tenor: These loans often have a tenor of 10 years as compared to three to five years for those provided by other lenders.
- Cash Flow Sweeps: Given the long tenor, insurance investors may be willing to provide for a longer cash sweep holiday, thus allowing the borrower to make more distributions to its investors in the initial years of the facility.
- Rating: These loans include either a requirement to obtain a rating prior to the closing of the facility or, if not obtained at closing, a covenant to use commercially reasonable efforts to obtain a rating within a specified period. Failure to obtain a specified investment grade rating can result in an interest rate step-up or accelerated cash sweeps.
- LTV Financial Covenant: In borrower-favorable deals, there might not be a financial covenant to maintain a loan-to-value ratio (LTV) below a specified threshold. Instead, when LTV exceeds specified thresholds, the result is a 100% sweep of distributions from the portfolio rather than a default.
Financings for Evergreen Funds
We have seen semi-liquid open-ended secondaries funds (also known as evergreen funds) gain in popularity in recent years, and more lenders are providing financing to these funds with the following key features:
- Blind Pool Revolvers: Lenders are willing to provide revolving facilities without approval rights over specific assets in the borrowing base so long as such assets are consistent with the fund’s investment strategy and meet certain minimum diversity requirements.
- Unsecured v. Secured: These facilities can be obtained either on a secured or on an unsecured basis. If unsecured, there will be a soft commitment from the entity receiving subscription funds to transfer amounts to a borrower collateral account in the case of an event of default or LTV breach.
Rated Feeders/CFOs
We have seen rated feeders and CFO transactions for secondaries funds or stakes come back in focus given that recent developments have provided greater regulatory certainty for U.S. insurers.We expect secondaries funds to take more advantage of these products, either as a fundraising tool or as a means of obtaining needed leverage.
Expectations for the Future
While secondaries NAV financings are by no means a new product in the fund finance space, the growth in secondaries fundraising and deal activity has spurred innovation in structures and terms. We expect this to continue, with market participants using more bespoke structures, and terms evolving on a deal-by-deal basis.
Private Equity Report Spring 2025, Vol 25, No 1