Private Credit x Secondaries - Are We Creating a New Frankenfund?

Recently I came across the new Loewe x ON Cloudtilt 2.0 collab and I have to say they do look amazing. They have the functionality that the ON Cloudtilt 2.0 offers with the superior material select from Loewe. However if you saw these shoes in public, you wouldn’t have thought for a second that they are a special collab with Loewe and ON. A trained eye might spot it but most people might just assume they are the normal ON Cloudtilt 2.0. I bring this up to show that there are fund structures that definitely have the characteristics of the Loewe x ON Cloudtilt 2.0.

Today, we will look at one such fund structure that learnt about in my journey. Recently on the Dry Powder podcast on April 28th 2025, Hugh MacArthur was joined by Pierre-Antoine de Selancy, Co-Founder and managing partner of 17Capital. They had a very interesting talk about 17Capital’s strategy and a lot of talk about NAV financing. I love listening to industry leaders in their space talk about their interest. You can feel the energy and passion they show for the space. But this podcast highlighted specific aspect that I didn’t previously consider. The collaboration of Private Credit and Secondaries to create a hybrid structure that offers NAV financing to Private Credit lenders by Secondaries investors looking for that sweet yield.

But I wanted to dive deeper into the work they did and how such structures could be helpful or hurtful. It warranted some introspection to understand what I was looking at. So I decided to take a look at 17Capital.

17Capital is often cited as a pioneer and leader. Since 2008 they have focused exclusively on providing NAV-based finance (initially via preferred equity, and now also via NAV loans) to PE investors. Firms like 17Capital essentially created this “white space” market, positioning themselves neither as traditional secondaries buyers nor as plain lenders, but as “in-between” flexible capital providers for funds and LPs. Over the last few years, success by 17Capital and a handful of others has drawn more entrants. A notable name is Whitehorse Liquidity Partners, which has raised multiple funds dedicated to providing preferred equity to private equity holders (LPs or GPs) as a liquidity solution. Whitehorse’s model is similar in spirit, they offer cash today through a structured pref equity investment, allowing the original owners to retain ownership and upside while Whitehorse earns a priority return. Beyond these specialists, we are seeing some traditional secondaries firms expand into structured NAV deals, and likewise some large private credit managers moving into this niche. On the credit side, major asset managers with private debt strategies (think of firms like Apollo, Blackstone Credit, Goldman Sachs, etc.) have the expertise to underwrite portfolio loans and are increasingly looking at NAV lending as an opportunity, especially after seeing banks pull back. In fact, the retrenchment of banks (due to regulatory constraints) has opened space for non-bank lenders to dominate NAV loans. examples of specialist banks might include Silicon Valley Bank (historically active in fund lending) or First Republic, although some of these faced issues in 2023, which only shifted more business to private lenders.

In summary, the players in this space include: dedicated NAV finance firms, 17Capital, Whitehorse, and a few newer entrants or spin-offs such as Dawson, large secondaries investors who have set up structured solutions teams, private credit funds seeking to deploy capital in NAV deals (some in partnership with secondaries teams), and occasionally banks or insurance companies that structure one-off NAV facilities. The market is still relatively concentrated. 17Capital’s co-founder noted that while interest is increasing, there are “very few pure-play participants” and not yet a glut of competitors. This allows established players to be selective: for instance, 17Capital reviews over 200 opportunities a year but executes around 10 deals, focusing on high-quality GPs (80% of their recent deals were with top-100 PE firms).

Now that we have a basic grasp on the market, let’s focus on the mechanics of NAV Lending, the basis of 17Capital’s strategies.

Deal structure in NAV financing can vary case by case, but there are common patterns. Typically, the lender (often a private credit fund or specialist financier) will extend a loan to a special-purpose vehicle (SPV) that either holds a slice of the fund’s portfolio or is contractually funded by the portfolio’s cash flows. The collateral usually includes: (a) equity interests in the SPV (which correspond to underlying portfolio companies or assets), (b) a security interest in the assets themselves or the proceeds from them, and (c) a pledge of any distribution accounts where sale proceeds or fund distributions flow. The loan agreement will set a borrowing base or LTV limit. For example, lend up to 20% of the NAV of the included assets, with each asset’s value perhaps haircut based on quality and liquidity. As the portfolio NAV changes or assets are sold, the facility size can adjust. Many NAV facilities are floating-rate loans (often priced at a spread over LIBOR/SOFR) with maturities of 1–3 years, sometimes extendable if portfolio exits are delayed. There are often financial covenants to protect the lender, such as minimum NAV coverage ratios (if NAV falls too much, the fund might need to repay part of the loan or not be allowed to draw further). These covenants help ensure the loan-to-value remains within agreed bounds.

One key structural point is that NAV loans are generally non-recourse to the fund’s LPs and the GP – the lender’s claim is confined to the assets pledged. To reinforce this, deals often require the SPV to be bankruptcy-remote (with independent directors, etc.) so that if things go south, the lender can seize and liquidate the collateral without entanglement in a fund insolvency. This protects LPs in the sense that their loss is limited to reduced NAV, not additional capital outlays. But it also means the lender will be highly focused on collateral quality and exit routes, since they cannot go after the GP/LPs for deficiency. In practice, if a default occurs, the NAV lender can enforce its security by selling the portfolio assets (or the SPV interests) to recoup the loan. For example, in a private credit fund NAV loan, the lender might auction off the underlying loans in the market to get repaid. In a private equity NAV loan, enforcement could mean forcing the sale of some portfolio companies or the fund’s interests in those companies.

NAV lending acts very much like debt so there are processes and precedents that provide a great roadmap for practitioners to follow. Distressed debt funds have been doing this for a very long time and therefore NAV lending is basically a version of distressed debt investing. Recently, I have been re-reading the distressed debt bible by Stephen G. Moyer. Going through the liquidation valuation section, I pondered over how this could be used in private companies where the companies are usually tech based companies with IP that may be worth something or just worthless. This thought train came back to this article about NAV lending. I wanted to understand what would be the risks associated with NAV lending for both the borrower and the lender. Additionally, understanding the effect such strategies may have on smaller LPs is also worth looking at as NAV lending is usually a last resort option to either speed up DPI or invest in opportunities that may increase IRR. Either way, let’s dive into the downfall and then the upside of NAV lending.

NAV lending introduces additional layers of risk and complexity that both GPs and LPs must weigh. Some key downsides and challenges include:

Increased Leverage and Opacity: NAV borrowing adds a layer of leverage on top of existing investment-level debt (in PE, portfolio companies often already have loans). This “hidden leverage” might not be immediately obvious in standard performance reporting. Combined with subscription credit lines and company-level debt, the total leverage stack can become opaque. LPs may not fully realize how much risk (debt) is embedded, which is especially dangerous in a downturn. This has raised concerns that NAV lending could be a “leverage trap”, masking fragility until a shock hits.
Valuation and Collateral Risk: Unlike bank loans on real assets, NAV loans are backed by private valuations that are infrequently marked-to-market. There’s valuation ambiguity, if NAV is overstated or gets marked down sharply, the lender may suddenly be under-collateralized. In stressed markets, private NAV can fall faster (or further) than anticipated, potentially breaching loan covenants before the GP can react. Both lenders and the fund face risk if loans were made against overly optimistic NAVs. Essentially, the collateral (private companies or loans) isn’t as liquid or certain in value as, say, public stocks, so mismatch in timing and valuation could bite. This valuation risk also is amplified if IP at the portfolio company level is suddenly devalued due to innovation. An example would be GPT wrapper companies who are now facing competition from Anthropic and OpenAI as a result of agentic workflow.
Covenant Breaches and Forced Asset Sales: Many NAV facilities include NAV coverage covenants or concentration limits. If the portfolio NAV drops beyond a threshold (say 30% drop), it might trigger a technical default or demand for partial repayment. In a downturn, this can create a vicious cycle: a declining NAV triggers a covenant, which forces the GP to sell assets at the worst time to reduce the loan – further locking in losses. This kind of liquidity spiral is exactly what NAV loans are meant to avoid, yet in a severe scenario they can end up causing it if not structured with enough headroom. The risk of “asset fire-sales” under duress is a real downside – it could negate the whole benefit of patient capital if covenants aren’t managed.
Cross-Collateralization Effects: NAV facilities often take a blanket lien on multiple assets (especially if the loan is to a fund or an SPV aggregating several investments). This means a problem in one portfolio company can spill over to others. For example, if one big asset in the pool fails or drops to zero, the lender may have the right to claw value from the other healthy assets to cover their loan. This cross-contamination can hurt LPs: normally, if one company fails it might just go to zero and not directly drag down others, but under a NAV loan, the loss of one asset may effectively consume part of the value of the others (from the LPs’ perspective) because the lender will take more of the remaining pie. In short, NAV lending can interlink outcomes of investments that would otherwise be independent, potentially reducing overall recovery for LPs in a bad scenario.
Cost Drag: The flipside of using leverage is the cost of capital. NAV loans typically come at a substantial interest rate (often high single or low double digits). If the fund’s assets don’t outperform this cost, the net result is a drag on returns. For instance, paying a 10% yield to a NAV lender decreases what’s left for LPs unless the borrowed money is generating more than 10% extra return. In a benign market this may hold true, but in a low-return scenario, the interest expense can eat away at LP profits. In particular, if a NAV loan is used and the portfolio then stagnates (or exits get delayed without value uptick), LPs could have been better off without the loan (they’d have lower IRR but possibly higher total value). Thus, there’s a risk of over-leveraging for insufficient benefit, especially if the GP misjudges the portfolio’s trajectory. This is why reputable lenders insist that NAV facilities not be used for fundamentally underperforming funds, the economics wouldn’t make sense if the expected return on assets is below the debt cost.
Governance and Alignment Issues: Introducing fund-level debt can sometimes create misalignment or governance challenges between GPs and LPs. For example, a GP might be incentivized to take a NAV loan to boost IRR or delay tough decisions (perhaps to aid their next fundraise), but that might not truly benefit LPs in the long run. Recognizing this, ILPA and others suggest that LP Advisory Committees (LPACs) should review and approve NAV facilities. If a GP unilaterally adds leverage, LPs may feel their risk was changed without consent. Additionally, if the GP’s fee is NAV-based, borrowing could keep NAV (and hence fees) higher for longer, which might conflict with LP interests unless carefully managed. Transparency is key: LPs should demand clear answers on why the loan is being used, how the proceeds will be used, and how it ultimately benefits them.
Systemic and Market Risks: On a broader level, some observers worry that the growth of NAV lending could introduce systemic risk in private markets. While the NAV loan market is relatively small in absolute terms, its interconnectedness and opacity raise echoes of pre-2008 structured finance. Many funds could have undisclosed leverage, and many private credit lenders could be exposed to similar portfolios, meaning a market downturn might have a cascade effect (for example, simultaneous NAV covenant breaches causing many funds to dump assets). The private markets are not mark-to-market daily, so these stresses can build unseen. Regulators and industry groups are thus monitoring this and calling for standards (leverage limits, disclosure, etc.) to mitigate excessive risk-taking.

In summary, the downside of NAV lending is essentially the downside of leverage – it amplifies negative outcomes and adds complexity. If the market goes against you, having a NAV loan can turn a manageable situation into a crisis (with margin-call-like effects). LPs could lose more of their capital than otherwise (due to lender claims), and GPs could lose control of assets if lenders enforce remedies. The best practice to avoid these pitfalls is: keep leverage modest (low LTVs), ensure the purpose of the loan is genuinely accretive, maintain transparency with LPs, and structure covenants with some cushion for volatility. When those are done, one can greatly reduce the risk of a NAV facility becoming a “leverage trap” instead of a useful liquidity tool.

So what are the benefits of NAV Lending if it has so many downsides. NAV lending, when executed for the right reasons, can offer multiple advantages in the context of secondaries and private credit:

Liquidity without Forced Sales: Perhaps the biggest appeal – a fund can raise cash without selling assets at an inopportune time. This means a GP doesn’t have to sell a portfolio company before it reaches full value, or an LP doesn’t have to sell its fund stake at a discount, just because they need liquidity. The NAV facility effectively bridges a timing gap, allowing investors to hold on to quality assets longer and avoid “locking in” a poor exit price. In volatile or down markets, this is a critical tool to wait for recovery.
Growth Capital and Value Creation: NAV financing can supply fresh capital for growth initiatives in mid/late fund life. GPs have used NAV loans to fund add-on acquisitions, expansion projects, or follow-on rounds that drive portfolio companies’ value higher. In a traditional fund, once the initial commitments are fully invested, the GP might miss these opportunities; with NAV finance, they can seize them and potentially deliver higher returns to LPs. It essentially extends the investment runway of the fund beyond the original capital.
Flexible LP Solutions: For LPs, NAV-based solutions provide alternatives to secondary sales. An LP with a portfolio of fund interests can borrow against them or engage a preferred equity provider, thereby getting liquidity while retaining upside. This avoids the painful discount negotiations around NAV that come with selling on the secondary market. Likewise, if a few LPs in a fund need out, a NAV loan can fund a tender offer or distribution that relieves those LPs without requiring a sale of the underlying assets. Overall, it adds flexibility to manage LP liquidity needs within a fund’s lifecycle.
Non-Dilutive Capital: NAV financing is generally non-dilutive to the GP’s and existing LPs’ ownership. Unlike bringing in a new equity investor or selling a stake (which transfers ownership or economics to a third party), a loan or pref equity doesn’t change who ultimately owns the assets if all goes well – it’s a temporary capital injection. For GPs, this means they don’t have to sell a piece of their management company or give up future upside in their fund assets. For example, some GPs use NAV loans to finance their GP commit for a new fund – rather than bringing in an outside investor to finance the commit (which could dilute their future profit share), they borrow against their existing fund’s NAV to raise cash and invest it into the new fund, thereby maintaining alignment and even “doubling down” on their own investments.
IRR and Cashflow Management: As noted, NAV facilities can help manage the cashflows and performance metrics of a fund. A carefully used NAV line can smooth distributions (e.g. allow regular payout to LPs even if exits are lumpy) and delay capital calls (reducing J-curve effect and cash drag for investors). This can make the fund’s return profile more attractive to LPs. While IRR “engineering” can be viewed skeptically, when combined with genuine value creation, it means a fund can deliver both real gains and a nicer-looking IRR by timing the cash flows efficiently. In the competitive fundraising market, demonstrating an ability to return some capital earlier or maintain strong IRRs mid-life can be a boon for GPs seeking to raise their next fund.
Bridge Fundraising Gaps: In some cases, NAV loans serve as bridges in fundraising or transition periods. For example, if a GP is between fundraises but encounters an investment opportunity, a NAV facility on the old fund can provide capital to “warehouse” that deal until the new fund is up and running. Or, as 17Capital observed, if a GP wants to expand into a new strategy or geography, they might use a NAV facility at the management company level (secured by their fund’s NAV or fee streams) to finance that growth initiative without immediately seeking a dilutive capital raise. This agility to pursue growth, succession planning (e.g. buying out a retiring partner’s stake via a NAV loan), or strategic moves is an often overlooked upside of NAV financing – it’s not just about shoring up old assets, but also about enabling future-oriented moves for the firm.

In essence, NAV finance is seen as a “tool to manage cashflows better and to optimize fund performance”, providing GPs and LPs with more options beyond the binary choices of either holding illiquid positions or selling them. When used appropriately, it aligns with the interests of both GPs and LPs: the GP can maximize value and avoid fire-sales, and the LPs ultimately receive higher returns (and possibly some interim liquidity) than they would have if assets were sold early or starved of follow-up capital. This is why NAV lending has moved from a niche to a mainstream solution among large PE firms in recent years.

So there are upsides when executed accurately and serve downsides when executed terribly. But as I mentioned earlier, there is a leverage effect at play at the fund level and the portfolio company level. Understanding the leverage effect in NAV financing is crucial to understand this space. So the question that most LPs would have in mind is “How much leverage is at play?”.

In a typical leveraged buyout fund, each portfolio company might have its own debt (often 50-70% of the company’s enterprise value is debt). That is asset-level leverage confined to each company. When a fund then takes a NAV loan (say 20% of the fund’s NAV), it’s effectively adding another layer of ~20% debt against the value of those companies. The combined leverage when looking through could be substantial. So for example, if a company is valued at $100 with $50 of its own debt (50% leverage), and the fund borrows another $20 against it via NAV facility, you have $70 debt on $100 asset value (now 70% “all-in” leverage). This is why ILPA cautions against “stacked leverage” – subscription line + NAV + company debt – as it can “mask portfolio fragility”. Each layer might look reasonable on its own, but together the cushion for equity is much thinner in a downturn. NAV lenders, aware of this, often set LTV caps considering total look-through leverage; for instance, they might lend less against highly levered assets. Nonetheless, it’s clear that NAV loans increase the overall leverage exposure of the fund’s strategy, which can magnify losses if asset values fall.

For private credit funds, the dynamic is slightly different since the “assets” are themselves loans. A credit fund might lever its loan portfolio 1:1 (so $100 equity and $100 NAV loan, for 50% LTV). The companies that those loans are made to already have debt (the loans in the portfolio), so one could argue there’s double leverage: the portfolio companies owe the credit fund, and the credit fund owes the NAV lender. However, from the companies’ perspective, they’re oblivious to the fund’s financing; they just pay their interest. The risk is borne by the fund and its LPs – if some borrower defaults, the credit fund’s NAV drops and now the fund has less coverage for its own loan. As noted earlier, credit fund NAV lines can go up to ~60-70% LTV for diversified books, which is quite high leverage – though the rationale is that diversified loan portfolios are lower volatility and generate current income to service the debt. Still, this means the credit fund’s equity could be quickly wiped out by a wave of defaults, leaving the NAV lender exposed (hence why these deals are carefully structured with borrowing bases and haircuts for lower-quality loans.

Impact on portfolio companies: In a direct sense, NAV lending is at the fund level, not the operating company level, so it doesn’t directly put additional debt on the companies’ balance sheets or interfere with their day-to-day operations. A portfolio company might not even know that its owner (the PE fund) has taken a loan against the fund’s stake. So the company’s financial statements and banking covenants remain as they were – thus, NAV leverage does not encumber the company’s assets or cash flows directly. This is a key distinction: from the company’s viewpoint, nothing has changed. But as we spoke about previously, the fund’s equity is at stake such a situation hence portfolio companies may also be exposed to cross-collataralization.

However, indirect effects can emerge. If a fund is NAV-leveraged, the GP’s decisions around the company might be influenced by the loan obligations. For example, suppose a fund borrowed to provide a distribution to LPs, expecting to repay once it exits a certain company. This could create pressure to exit that company by a deadline (the loan maturity), possibly even selling a bit sooner or at a lower price than they would in an unlevered scenario, just to meet the debt timeline. If markets are unfavorable at that time, the company might be sold under less-than-ideal circumstances – which isn’t great for the company’s growth prospects or the ultimate price. Another scenario: if a company hits a rough patch and needs additional capital, a GP with no NAV debt might say “let’s inject more equity from the fund to support it.” But a GP who has a NAV loan and tight covenants might not have the flexibility (or spare capacity under the loan) to do so. In a worst case, if the company’s troubles cause a NAV writedown that trips covenants, the GP could be forced by the lender to sell the company quickly to shore up NAV, rather than working to fix it. This kind of lender-driven sale could be disruptive for the company (new ownership abruptly, perhaps a breakup sale). Additionally, cross-collateralization means even a healthy company could be sold early because another company failed – the lender might require that the best assets get sold to repay the loan if the worst assets implode. So the portfolio companies may face earlier or unplanned exits due to fund-level loan dynamics, which can affect the companies’ trajectory (they might end up with a different owner sooner than expected, etc.).

In summary, while NAV lending doesn’t burden the portfolio companies with direct debt, it does add financial constraints at the fund level that can indirectly influence the fate of those companies. There is more financial engineering overlay on the portfolio. If everything goes smoothly, the companies shouldn’t feel any impact – the fund simply continues to support them and eventually sells them when ready, paying off the NAV loan from proceeds. But in a stressed situation, the companies could become chess pieces to satisfy the lender. For example, being sold or having their distribution flows diverted to the NAV lender. This underscores why NAV leverage must be used in moderation; GPs need to retain enough flexibility to act in the companies’ long-term interest, and LPs need to be comfortable that the additional leverage won’t jeopardize the fund’s ability to maximize value.

NAV lending in secondaries and private credit represents a powerful but double-edged tool. It has rapidly moved from the fringes to the mainstream as GPs and LPs seek creative solutions in an era of prolonged fund lives, slower exits, and capital constraints. On one side of the coin, NAV finance is a liquidity and growth enabler – it allows investors to unlock value without relinquishing assets, to enhance returns through prudent leverage, and to navigate market timing with greater agility. The success of firms like 17Capital and the uptake by top-tier PE managers show that, used judiciously, NAV loans and preferred equity can be accretive and even become a standard part of the fund management toolkit. On the other side of the coin, NAV lending, like any leverage, amplifies outcomes and risks. It requires skill and discipline to ensure that the benefits outweigh the costs. LPs and GPs must actively manage the transparency, covenants, and total leverage to avoid hidden dangers.

In assessing NAV lending, one should ask: Is it a tool or a trap? The answer ultimately depends on execution. When applied to high-quality assets with growth potential, and sized conservatively, NAV finance is a tool that can optimize a fund’s performance and provide flexibility in uncertain times – a true win-win for GPs and LPs. But when used to merely delay the inevitable or pile debt on stagnating portfolios, it can become a trap, eroding returns and adding stress to an already illiquid situation. As one 2025 industry commentary put it, _“NAV lending isn’t inherently risky. Used judiciously, it’s a powerful fund management tool… But like all leverage, it amplifies outcomes… in an opaque corner of the market, that amplification can go unnoticed – until it matters most.”

My takeaway for smaller LPs and others less familiar, the key is to stay informed and engaged. NAV lending in secondaries is likely here to stay, evolving alongside GP-led secondaries and other innovative capital solutions. With proper checks and balances such as ILPA’s guidelines on disclosure and leverage limits. The hope is that this market will mature responsibly. In any case, understanding the mechanics, benefits, and risks of NAV lending (as we’ve outlined above) is crucial for anyone involved in private market investing today. It is a realm where private credit meets private equity, creating both opportunity and complexity, and only through careful structuring and oversight can one ensure that the leverage effect works for you and not against you.

As always, stay informed and stay safe!