Private equity firms are attempting to get blanket permission to borrow against their funds’ assets — a trend that’s exasperating some investors.

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Stone Point Capital, which is raising money for its 10th buyout fund, is one such firm.

It included language in its fund agreement allowing it to borrow against the vehicle’s assets at any time, according to a person familiar with the matter, who asked not to be identified discussing confidential information.

That provision would empower the Greenwich, Conn.-based buyout firm to borrow on a so-called net-asset-value loan — a once-unorthodox form of private credit that has grown in popularity as a way for private equity firms to raise cash during prolonged lulls in fundraising and dealmaking.

But some investors in private equity funds — known as limited partners — are skeptical of firms adding debt onto an already-leveraged portfolio, according to interviews with a half-dozen backers, who asked not to be named discussing private deliberations. Those limited partners are challenging clauses in fund agreements that give firms carte blanche to tap NAV loans, said the investors, which include pension funds.

“Generally, they almost always receive some kind of pushback,” Barrie Covit, a partner in Simpson Thacher’s fund group, said in an interview, speaking broadly about NAV loans.

Stone Point didn’t reply to messages seeking comment.

Private equity’s reliance on NAV loans has exploded in recent years as traditional sources of financing — such as selling portfolio firms or leveraged loans — have become harder to access. Private credit firms are raising funds to offer the loans as banks rein in lending amid a regulatory crackdown in response to last year’s regional bank crisis.

Law firm Kirkland & Ellis has been particularly active in inserting language into documents for new funds that would allow firms to take out NAV loans without getting investors’ permission or even notifying them, according to people with knowledge of the matter. 

Kirkland & Ellis declined to comment.

More Risk

The value of NAV loans is typically less than 25 percent of the assets the firm is borrowing against, which is generally considered a low loan-to-value ratio. Still, some investors view the loans as risky financial engineering.

Robert Smith’s Vista Equity Partners has been raising money for its latest private equity fund for more than two years. The firm took out a $1.5 billion NAV loan last year to make distributions to investors and encourage them to commit to the next buyout pool.

Meanwhile, investors in French private equity firm PAI Partners were irked last year when they learned that it had used a portion of a NAV loan to pay distributions, according to another person with knowledge of the matter.

Representatives for Vista and PAI declined to comment.

One of investors’ big concerns is that NAV loans can increase portfolio companies’ exposure to potential weaknesses in other investments. By contrast, when a particular company takes on debt, it’s exposing only itself to default and other risks instead of an entire portfolio of firms.

Some limited partners may still support NAV loans if they deem using the debt to be the most cost-effective way to invest in portfolio companies, according to Allen Waldrop, director of private equity investments at Alaska Permanent Fund Corp.

But the Alaska fund doesn’t support those loans if private equity funds are “just leveraging the portfolio to get distributions,” he added. “You’re just layering on more risk.”

Limited Power

Fund documents historically haven’t addressed the question of whether a private equity fund can tap into these types of loans, and some firms have interpreted the absence of language governing NAV loans as unrestricted consent. 

The lack of clarity makes now an ideal time to create standards and practices for the loans, according to some institutional investors. Limited partners are pushing firms to inform them before pursuing a NAV loan. Fund investors are also trying to insert language into fund documents that would explicitly require the firm to get approval from their limited partner advisory committee, or a majority of LPs.

Meanwhile, some investors are trying to change old agreements on their existing fund investments and looking at how to insert language in new fund documents that addresses both NAV loans and other funding structures that could proliferate over the five to 10 years of a fund’s life.

But limited partners — especially large institutional investors — have limited bargaining power. 

As much as they might object to NAV loans, fund investors also realize they can’t push back too much because they might not have an alternative private equity firm to take their cash.

“The biggest investors especially are more constrained because they need to deploy large sums, and not all investment firms can take a $500 million ticket for example,” said Neal Prunier, senior director of industry affairs at Institutional Limited Partners Association.

Prunier’s firm, a trade association for investors in private equity, is expected to publish a report on best practices for NAV loans later this year.

Ultimately, if investors prefer private equity firms to curb their use of these controversial loans, they might have to wait until it’s easier to exit investments.