Fund Finance: Subscription Lines vs NAV Loans

Most discussions of leverage focus on the deal — the debt on the portfolio company. But funds borrow too, above the LP equity layer, at the fund level. The two dominant forms are subscription lines and NAV loans. They look superficially similar (both are fund-level facilities) but they are secured by completely different things and used at opposite ends of the fund's life.

Subscription lines (capital call facilities)

A subscription line — "sub line" or "capital call facility" — is a revolving credit facility secured by the fund's right to call undrawn capital from its LPs. The collateral is not the portfolio; it is the LPs' unfunded commitments and the GP's ability to draw them.

How it works

• The lender advances money against the creditworthiness of the LP base and the size of undrawn commitments.
• The fund uses the line to pay for investments and expenses before calling capital from LPs.
• Periodically, the GP calls capital and repays the line.

Why GPs use it

• Operational convenience — one or two capital calls per year instead of a call for every deal. Easier on LPs' treasury functions.
• Speed — the fund can fund a closing immediately and true up with LPs later.
• Bridging — smoothing the timing between when cash is needed and when it is called.

Sub lines are widely accepted, relatively uncontroversial, and cheap because they are secured by high-quality, diversified commitments from institutional LPs. Pricing is a modest spread over a benchmark rate.

NAV loans

A NAV loan is secured by the net asset value of the fund's actual portfolio — the equity stakes in the companies the fund already owns. It is drawn later in the fund's life, once capital is deployed and there is a portfolio to lend against.

How it works

• The lender advances against the value of the underlying investments, typically at a conservative loan-to-value ratio.
• The loan sits above LP equity at the fund level and is repaid from portfolio realizations (or a refinancing).

Why GPs use it

• Liquidity without selling — return capital to LPs or fund follow-on investments and bolt-ons without exiting positions into a soft market.
• Portfolio support — inject capital into a company that needs it, financed at the fund level rather than the OpCo level.
• Bridging distributions — provide DPI (distributions to paid-in capital) to LPs while holding assets for further value creation.

The IRR-smoothing debate

The most contentious feature of sub lines specifically is their effect on reported returns. Because a sub line delays the moment LP capital is actually drawn, and IRR is a time-weighted return that rewards deferring the outflow, a longer-dated sub line can increase the fund's reported IRR — sometimes materially — without changing a single underlying investment outcome.

The tension:

• GP view: IRR is a legitimate metric; sub lines are an operational tool, and sophisticated LPs can adjust.
• LP view: Sub-line-boosted IRR can flatter a track record and complicate comparisons between managers. Many LPs now ask for returns reported both with and without the sub line's effect, and industry bodies (such as ILPA) have pushed for exactly that transparency.

The key discipline is separating manager skill from financing engineering. A high IRR that is partly a product of a long sub line is not the same as a high IRR from good investing.

Risks

Both instruments add leverage above the LPs, which means both amplify outcomes — good and bad.

Subscription line risks

• LP default risk — the collateral is only as good as the LPs' willingness and ability to fund calls; a wave of LP distress could impair the security.
• Extended tenor risk — the longer the line stays out, the more it distorts IRR and the more it embeds cost.

NAV loan risks

• Cross-collateralization — a NAV loan is typically secured by the whole portfolio, so a facility taken to help one struggling company can put healthy companies' value at risk.
• Leverage on leverage — the portfolio companies already carry their own debt; a NAV loan adds a second layer of leverage on the same assets, magnifying downside.
• Distributions funded by debt — using a NAV loan to pay LP distributions can look like returning capital when it is really borrowing against the portfolio, potentially deferring rather than creating value.
• Valuation dependence — the borrowing base rests on the GP's own NAV marks, which are inherently subjective.

The growth and controversy of NAV lending

NAV lending has grown rapidly as exit markets slowed and GPs sought liquidity without selling assets into unfavorable conditions. That growth has drawn scrutiny:

• LP consent and disclosure — LPs increasingly want a say in whether the GP can encumber the portfolio, and clearer disclosure of how proceeds are used. Some fund documents did not clearly contemplate NAV loans, raising questions about GP authority.
• Use of proceeds matters enormously — a NAV loan to fund an accretive follow-on is very different from one used to manufacture early distributions and flatter DPI.
• Alignment — critics argue borrowing to pay distributions can serve GP incentives (carry, fundraising optics) at LPs' long-term expense; defenders argue it is a rational liquidity tool in a frozen exit market.

The bottom line

Sub lines are a mature, well-understood convenience with one real controversy — their effect on reported IRR. NAV loans are a newer, more powerful, and more contested tool that leverages the portfolio itself. Both can be used responsibly. The questions that separate good practice from bad are always the same: What is the collateral? What are the proceeds used for? And is the reported return honest about the role financing played?