NAV Financing vs Continuation Vehicle: Two Answers, One Clock

Both answer the same problem: the clock is running down and holdings have not been sold. The two arrangements answer it in completely different ways. Borrowing against the holdings leaves every one of them exactly where it is and adds a lender. A continuation vehicle sells one holding to a new fund the same manager runs, so the manager sets both prices. Neither has been done here.

A reader usually meets these two ideas in the same sentence, in the same paragraph of the same article, joined by the word or. Sharing a sentence is the whole reason the two need separating. Both answer one question: what a manager can do when the contracted life of a fund is nearly over and the holdings have not turned into cash. Beyond that shared timing they have almost nothing in common. One of them creates a debt and changes no holding at all; the other changes a holding and creates no debt. Every other difference between the two follows from that one sentence.

Everything below is worked on Nilgiri Growth Partners Fund II, invented, a closed-end fund managed by Nilgiri Alternatives Advisors Private Limited, invented. Both arrangements are worked as counterfactuals: they are what this manager could reach for, and this fund has done neither of them. A counterfactual labelled once at the top of a section gets quoted out of the middle and read as a thing that happened, so the label is repeated on every sentence and inside every figure below.

What problem are both of these trying to solve?

The position of the fund actually happened. Both arrangements below did not, so the position comes first. Nilgiri Growth Partners Fund II, invented, has a contracted term of ten years from its final close. Its record date is the end of its Year 9 Quarter 2, 8.50 years after that close. At that date six quarters of the contracted term remain. Its own documents carry two extensions of one year each, the first at the manager's election with the prior written consent of the investor advisory committee and the second requiring the consent of investors holding more than half of commitments by value. Neither extension has been taken at the record date. Because those two extensions exist, the six quarters are not an absolute wall.

The fund entered nine holdings. Three have been sold in full, one was written off in full, and one has been part sold. Five positions are still there, carried at Rs 2,82,00,00,000 in total at the record date, and not one rupee of that Rs 2,82,00,00,000 has been sold to anybody. The Rs 2,82,00,00,000 is not cash. A net asset valueThe reported total of what a fund still holds. is the reported total of what a fund still holds. Ashwin Baliga, the fund controller at Kolar Fund Services Private Limited, invented, strikes that total on marks that Palani Valuation Advisors LLP, invented, signs off.

Put those two facts beside each other and the problem stands in one line: a fixed amount of time left, and a large number that has never been tested against a buyer. A fund in that position is not in a crisis. The position is the ordinary one for a fund in its ninth year, and it is exactly the position in which a manager gets asked what else there is besides selling five companies in eighteen months.

Now the two answers. The first is a loan, and it is a counterfactual: the fund would borrow against the five remaining holdings taken together, rather than against any one of them, and distribute what it borrows. The second is a sale, and it is a counterfactual too: holding 4 would be sold into a newly formed vehicle that the same manager runs, and the existing investors would be offered a choice between taking the cash and continuing into the new vehicle. Both are counterfactuals and Nilgiri Growth Partners Fund II, invented, has done neither.

Notice what the two sentences above have in common, and notice what they do not. Only the timing is shared. In the first, no company changes hands, no buyer is found, nothing is negotiated about any holding, and at the end of it the fund still holds exactly the five positions it held at the start. In the second, one company changes hands, a price has to be agreed, and at the end of it the fund holds four positions instead of five. The borrowing counterfactual is a financing and the continuation vehicle counterfactual is a transaction, and almost everything else about them follows from that distinction.

What actually happens to the five holdings in each one?

Only one thing separates the two arrangements, and it repays being slow and literal: what happens to the holdings. Take a household example first. The shape is identical and the rupees are smaller. Suppose a household has agreed to hand back a rented godown by a fixed date and there is still stock inside it that nobody has bought. There are two very different things it can do. The household can go to a lender, borrow against the whole stock as one lot, and hand the borrowed money to the people it owes. Every carton stays exactly where it was, and now there is a loan sitting on top of the stock. Or it can sell one item to a new arrangement that the same person happens to run, and hand that money over instead. One carton has genuinely left the godown, and there is no loan anywhere.

Under counterfactual A, the borrowing, not one of the five holdings of Nilgiri Growth Partners Fund II, invented, moves. Holding 4, Bhavani Speciality Chemicals Private Limited, invented, is still there. So are holdings 6, 7, 8 and 9. Nobody has valued any single one of them for the purpose of a sale, nobody has negotiated with a buyer, and no shareholders agreement has been touched. The counterfactual loan is against all five taken together. A loan of that shape is described as a loan against the fund's holdings rather than a loan against a company. One thing has changed: the fund now owes somebody money, and that somebody has to be repaid before the investors see the rest.

Under counterfactual B, the continuation vehicleA new fund, run by the same manager, that buys a holding from the old one., exactly one thing moves and it moves completely. Holding 4 would stop being an asset of Nilgiri Growth Partners Fund II, invented, and would become an asset of a new vehicle. The fund is left with four holdings, being 6, 7, 8 and 9, carried at Rs 21,00,00,000, Rs 39,00,00,000, Rs 81,00,00,000 and Rs 33,00,00,000. The four come to Rs 1,74,00,00,000 between them. A sale of a holding is a sale whoever the buyer is, and the fact that the buyer is a vehicle the same manager runs changes who sets the price, not whether the holding has left. Both of those are counterfactuals and neither has been carried out.

One detail on that figure catches readers out everywhere in this subject, and it is worth pausing on. The five printed shares of the pool are 38.3, 7.4, 13.8, 28.7 and 11.7 per cent, and those five printed figures add to 99.9 rather than 100.0. Nothing is missing. The unrounded shares add to exactly 100.0000, and the printed column is short because five separate roundings were done independently. The correct response is to say so, rather than nudging one of the five so that the column looks tidy.

Who is on the other side, and who sets the price?

The answer involves who signs what, so one sentence about the shape of this fund comes first. Nilgiri Growth Partners Fund II, invented, is settled as a trust. Nilgiri Trusteeship Services Private Limited, invented, is the trustee and holds the assets. Nilgiri Alternatives Advisors Private Limited, invented, is the investment manager and makes the investment decisions. Nilgiri Financial Holdings Private Limited, invented, is the sponsor. The global vocabulary of this subject speaks of a general partner, and in this fund that role is discharged by the manager and the trustee between them, under a trust deed and a contribution agreement rather than a partnership agreement. The manager is the party that would negotiate either arrangement, so everything below says manager.

In counterfactual A, the borrowing, the party on the other side is a lender. The lender is not connected to the manager, is not connected to the fund, and wants to be repaid. Two things follow from that and they are the whole reason a lender is a different kind of counterparty. First, the price is settled by two parties who can each walk away, and neither of them controls the other's decision. Second, the lender is not buying a view about what holding 4 is worth; it is deciding what it is willing to advance against the five taken together and on what terms. This fund has not borrowed and the record fixes no cost of borrowing, so the price of such a loan is nowhere established.

In counterfactual B, the continuation vehicle, the party on the other side is a fund that the same manager runs. Sit with the arithmetic of that for a moment. The manager decides, on behalf of Nilgiri Growth Partners Fund II, invented, what price is acceptable to sell holding 4 at. The manager would also decide, on behalf of the new vehicle, what price is acceptable to buy it at. The same firm is answering both halves of a negotiation that ordinarily has two firms in it, and there is no way to arrange a continuation vehicle in which that is not true.

What does each one do to the reported columns?

Investors in a fund like this one watch a small number of columns, and one of them is distributions to paid inCumulative distributions divided by cumulative capital contributed.. The column is a division and nothing more: everything the fund has ever paid out, divided by everything it has ever called in. For Nilgiri Growth Partners Fund II, invented, at its Year 9 Q2 record date, that is Rs 4,38,00,00,000 of cumulative distributions over Rs 4,80,00,00,000 of cumulative capital drawn. The division gives 0.9125, and the fund's own reporting writes it as 0.91. The same numerator over a different denominator is a different number, and readers swap them constantly. Name the denominator every time.

Why does that particular column matter more than most? Because it answers the question everybody actually asks: how much money has come back. A column of 0.9125 says that for every rupee called in, 91.25 paise has been returned in cash. A column below one has a plain meaning: cumulative distributions sit Rs 42,00,00,000 short of cumulative capital drawn, being Rs 4,80,00,00,000 less Rs 4,38,00,00,000. Every rupee investors have received so far has been a return of what they put in, and the fund has not yet given all of it back.

Now run counterfactual A, the borrowing, and watch what happens to that column. Twenty per cent of the Rs 2,82,00,00,000 carrying value is Rs 56,40,00,000. The Rs 56,40,00,000 is hypothetical, and it is 20.0 per cent of the Rs 2,82,00,00,000 that the five unsold holdings are carried at, not of the Rs 4,80,00,00,000 drawn and not of the Rs 4,38,00,00,000 distributed. Naming the base is what stops a reader guessing which one produced the figure. Distribute that Rs 56,40,00,000 and the numerator becomes Rs 4,94,40,00,000 while the denominator stays exactly where it was. The column becomes 1.0300.

The addition is the cleanest arithmetic in this guide. Rs 56,40,00,000 over Rs 4,80,00,00,000 is 0.1175. And 0.9125 plus 0.1175 is 1.0300 exactly, with nothing rounded and nothing left over. The column crosses one, the Rs 42,00,00,000 gap between distributions and capital drawn is more than covered with Rs 14,40,00,000 to spare, and not one holding has been sold to anybody. Both of those sentences describe the same event, and the second one is the one that falls out of most retellings.

Counterfactual B, the continuation vehicle, moves a column too, but it moves it in a different way. Holding 4 is carried at Rs 1,08,00,00,000. The price of holding 4 is precisely the thing at issue below, and no sale has happened, so the record fixes no price for one. No figure for what the sale would fetch therefore exists. The arithmetic at the carried figure can still be run. If a sale were struck at Rs 1,08,00,00,000 and every rupee of it were distributed, the numerator would become Rs 5,46,00,00,000, the column would read 1.1375, and the value still held would fall from Rs 2,82,00,00,000 to Rs 1,74,00,00,000. All three figures are arithmetic on stated conditions, not a statement about what anybody would pay.

How each of those movements is presented in a quarterly report, what a reported total contains and how an unsold holding gets its mark in the first place are all covered separately; the reported figures are used here as given.

Which of the two carries a conflict that cannot be designed away?

A reader who is handed the process first hears reassurance and then has to work backwards to the problem, and most readers never do the second half of that. So the conflict comes first, with nothing wrapped around it.

In counterfactual B, the continuation vehicle, Nilgiri Alternatives Advisors Private Limited, invented, decides what price Nilgiri Growth Partners Fund II, invented, will accept for holding 4, and also decides what price the new vehicle will pay for it. In that counterfactual a lower price would be worse for the investors who take cash and better for the new vehicle, and the manager runs both of them. Setting both prices is a structural conflictOne built into the arrangement rather than caused by conduct., meaning it comes from the shape of the arrangement rather than from anything anybody did. The conflict exists on the first day, before a valuation has been commissioned, before a price has been discussed and before anybody has behaved well or badly.

The everyday version is familiar to anybody who has watched a house being sold inside one household. If the person selling the house and the person buying it are the same person acting for two sides, the price is whatever that person says it is. Nobody has cheated anybody. The mechanism that normally produces a price is two parties with opposite interests pushing against each other, and that mechanism is simply not present. A structural conflict is not an accusation and it is not a prediction of bad conduct; it is a statement about what is missing from the machinery that would otherwise set the number.

Counterfactual A, the borrowing, does not have this. The manager negotiates with a lender who is not connected to it, wants its money back, and has its own view of what the five holdings are worth as security. The manager can push, the lender can refuse, and there is no arrangement in which the manager decides both halves. The absence of that conflict does not make the borrowing better, safer or more suitable. The borrowing is a different kind of arrangement with a different set of things to look at, and that is the only comparison worth drawing.

Conflicts on this fund are handled under its own documents, and a sale into a continuation vehicle is one of a numbered set of four conflicts that its arrangements name. The others concern how an opportunity is allocated between two vehicles the same manager runs, how any fee taken at a portfolio company is treated, and what happens when more money goes into a holding that is struggling. The other three are covered separately and are not compared here.

What answers that conflict, and what does not?

Now, and only now, the process. Four things sit against the conflict named above, and each of them is a control on something that is still there rather than a cure for it. The four are an independent valuation of the holding being sold, a fairness opinionAn outside view on whether a price is defensible. on the price, the consent of the investor advisory committee, and a genuine cash optionThe choice to be paid out rather than continue. for anybody who does not want to continue.

Take them one at a time on this fund's own arrangements. An independent valuation means somebody outside the manager puts a figure on holding 4. Nilgiri Growth Partners Fund II, invented, already retains Palani Valuation Advisors LLP, invented, as its independent valuation agent, with Rohit Vaz, invented, as signing partner. A fairness opinion is a separate outside view on whether the price actually being paid is defensible. Marking a holding is not the same exercise. The investor advisory committee of this fund has seven members drawn from seven of its twelve investors and is chaired by Meera Sathe, invented, for the largest of them, and it consents on conflicts. Note what it is and is not: it consents, and it does not approve investments and cannot reject one. Confusing that committee with the manager's own investment committee is the commonest mistake a reader makes about a private fund's governance, and the governance structure itself is covered separately.

The fourth control is the one people skim and it is the one that carries the most weight. In that counterfactual investors would be offered a choice between taking cash and continuing into the new vehicle, and to rollTo take an interest in the new vehicle instead of cash. is to take an interest in the new vehicle instead of the cash. The choice is only a choice if the cash is genuinely available to anybody who asks for it, on terms that do not punish asking. Without that, an investor who wanted out would be carried into a new vehicle on new terms by default, and its consent would mean very little. The cash option is what turns a decision about somebody else's money into a decision each investor makes for itself.

If the fund borrows, what happens to the investors' eventual total?

Headlines drop the arithmetic that follows, and an account of the borrowing that does not run it offers a number rather than an explanation. The conclusion does not depend on any rate of interest, so no rate is assumed below.

The total cash that the five remaining holdings eventually produce can be written as a single unknown. Call it P. The record stops at the Year 9 Q2 record date and nothing after it exists, so P is neither estimated nor projected and what any holding will fetch is unknown. Everything below is true for any value of P at all, and being true for any value is precisely what makes it worth writing.

Without counterfactual A, investors of Nilgiri Growth Partners Fund II, invented, eventually receive the Rs 4,38,00,00,000 already distributed to them, plus P. With counterfactual A, they receive the Rs 4,38,00,00,000 already distributed, plus Rs 56,40,00,000 now, and then later, out of P, whatever is left after the same five holdings have repaid the Rs 56,40,00,000 with the interest and costs that ran on it. So the second line is Rs 4,38,00,00,000 plus Rs 56,40,00,000 plus P minus Rs 56,40,00,000 minus the interest and costs. The two Rs 56,40,00,000 cancel exactly, leaving Rs 4,38,00,00,000 plus P minus the interest and costs. The second line is therefore lower than the first by the interest and the costs and by nothing else.

The result is the honest half of the borrowing counterfactual, and it belongs beside every retelling of the Rs 56,40,00,000. Say it in plain words. The counterfactual loan has to be repaid out of the same five holdings, with interest, so the investors' eventual total is lower, not higher. The money did not come from the holdings performing. The money came from a lender, and a lender is paid for the time. The arrangement changes when investors receive money and what the reported column says in the meantime. The arrangement cannot change how much those five companies are eventually worth to somebody.

What does neither of these arrangements do?

A comparison is only finished when it says what is common to both sides, and here the common ground is larger than it looks. Neither arrangement makes Nilgiri Growth Partners Fund II, invented, worth more than it was the day before. Neither of them changes what Bhavani Speciality Chemicals Private Limited, invented, or any of the other four companies is worth to an eventual buyer. Neither of them sells the four holdings that are not holding 4. At the record date those four are carried at Rs 21,00,00,000, Rs 39,00,00,000, Rs 81,00,00,000 and Rs 33,00,00,000. Neither of them extends the contracted term by a single day; the extensions in this fund's documents are a separate mechanism and neither has been taken.

Each arrangement moves things around inside the same total, and the arithmetic shows it cleanly. At the record date, this fund's cumulative distributions over cumulative capital drawn are 0.9125 and the value it still holds over the same capital drawn is 0.5875. The two add to 1.5000 exactly, and that addition is the check worth running on any reporting of this kind: the cash that has come back plus the value still held, both over the same denominator, is the total value against paid in capital.

Run counterfactual A through that identity, carrying the loan as a deduction from the value still held, and the columns read 1.0300 and 0.4700. The two add to 1.5000. Run counterfactual B at the carried figure of Rs 1,08,00,00,000 with every rupee distributed, and the columns read 1.1375 and 0.3625. The pair adds to 1.5000. Neither arrangement creates value, and both of them only change which column the value sits in, so three different pictures of the same fund on the same day add to exactly the same total. Whether a report would present the obligation that way is a reporting question, covered separately; the deduction is made here so that the two columns still describe everything the fund is worth.

One more thing neither of them does, and it is the one that matters most to an investor reading either announcement. Neither turns an estimate into a result for the rest of the portfolio. Under counterfactual A, Rs 2,82,00,00,000 of carrying value has still never been tested against a buyer, and now there is a claim standing in front of it. Under counterfactual B, one holding has been tested, but against a buyer that the same manager runs. A sale to a connected buyer is a weaker test of a price than a sale to somebody unconnected. The rest of the pool is exactly as untested as it was.

With an hour to spend on a fund in this position, what is worth asking?

Very few readers will ever run either arrangement, and a great many will read about one in a report, a news item or an investment committee paper and have to work out what it actually means. A lender's credit team, an analyst covering a manager, an investor sitting on an advisory committee and a household reading a statement all end up asking the same five questions, in the same order.

First, work out which of the two this is. The answer sorts every other question, so ask whether a holding has changed hands or a lender has appeared. If the announcement says an amount was distributed and lists the same holdings afterwards, it is a financing. If it says one company now sits somewhere else, it is a transaction.

Second, what is the denominator? A borrowing described as twenty per cent is twenty per cent of something, and in this worked case it is 20.0 per cent of the Rs 2,82,00,00,000 that the five unsold holdings of Nilgiri Growth Partners Fund II, invented, are carried at. Twenty per cent of the capital drawn would be a very different figure. The same discipline applies to any column that moves: 0.9125 and 1.0300 are both divisions by the Rs 4,80,00,00,000 of capital drawn, and a reader who does not know the denominator does not know the number.

Third, what is owed afterwards, and out of what? If it is a financing, the repayment comes out of the same holdings that were already the only route to cash, with interest on top, and the eventual total is lower by that interest. Ask how large the obligation is and whether the reported value of the holdings is shown before or after deducting it. Each answer gives a different picture of one fund.

Fourth, who set the price, and what was done about it? If the buyer and the seller share a manager, say so first and ask about the four controls second: an independent valuation, a fairness opinion, the advisory committee's consent, and whether the cash option is real. A cash option that exists on paper and is hard to take is not one.

Fifth, what has actually been sold to somebody unconnected? No arrangement in this subject removes that question. On this record the answer is unchanged by either counterfactual: Rs 2,82,00,00,000 of Nilgiri Growth Partners Fund II, invented, had never been sold to anybody at its Year 9 Q2 record date, and an arrangement that moves money without moving that figure has not answered it.