The rise of Continuation Funds… What, and why.

In recent years the use of continuation funds has been steadily growing in popularity with fund managers. In our latest article, Altum Group’s Matthew Devine-Hill explains the  potential reasons why investors see this as a steadier return and why it has gained popularity he also provides an overview of the benefits and areas of risks fund managers, Limited Partners and administrators need to be aware of. 

Investing for the long haul…what is a continuation fund?

First thing first, a continuation fund is exactly what it says it is, it is a fund in its truest form, however, the key difference is how it is utilised by managers.

One of the key characteristics of a traditional private equity fund is that they have a set duration with a typical term being ten years (+ two, one-year extensions usually at the discretion of the General Partner). Selling private equity assets within the set time may not always be so straight forward and not the best option for the Limited Partners due to low exit price or the asset hasn’t reached its full potential… so, what can the General Partner and Manager do in this instance?

This is where a Continuation fund structure would come into play… By setting up a new fund structure (with a new fund term life) the chosen assets can be transferred/purchased from the fund coming to the end of its life therefore allowing the Manager to continue to hold the asset until the optimal time to exit, while also giving the Limited Partners in the legacy fund the option of holding on and investing into the continuation fund or to get liquidity from the sale.

But why have they been so popular recently?

There have been various factors leading to the popularity and increased use of Continuation funds in the last couple of years. According Preqin data, a major factor to the increased use of these structures is driven by tough “Economic conditions and a slow M&A market that took a toll on deal-making in 2024. In 2023, to date, 7, 699 deals with a total value of US$498.6 bn…down 19% and 33%, respectively, on full-year totals for 2022.”

Given a lack of deal flow and tough market conditions including the rapidly rising interest rates, entrenched inflation, and geopolitical instability, which has caused significant capital market constriction which we have all witness during the course of 2022 and 2023, coupled with decreased valuations across many asset classes, Mangers have turned to the use of Continuation Funds as a solution of creating liquidity.

Benefits of a Continuation Fund

If these potential areas are managed correctly then continuation funds can provide several benefits that traditional exits may not provide to GPs, Limited Partners, but also to portfolio companies.

From the existing Limited Partner point of view, Continuation funds gives existing investors options with access to liquidity, rebalance and de-risk their portfolios and re-deploy their capital elsewhere.

For the Limited Partners who decide to roll and continue their investment, the assets that are selected to build the portfolio of the Continuation Fund tend to be high-performing portfolio companies that they know well, which is also a benefit for new investors as well. Continuation Funds provide a way to invest in mature, pre-identified and generally high-performing portfolio companies with holding periods that are shorter relative to the holding period of a primary fund, alongside a GP that has managed and is familiar with the portfolio companies.

From a Manager perspective, it provides an opportunity to the GP to access additional dry powder in the form of additional unfunded commitments from the rolling and new investors and from the GP itself.

The portfolio companies may also benefit from the creation of a Continuation Fund which provides continued confidence and continuity with a sponsor that knows the portfolio companies well. It can avoid potential disruption from new ownership resulting from a sale or other liquidity events.

Sounds great, right?!

There are however, several key areas that need to be managed carefully when considering whether a continuation fund is the right move.

1. Conflict of Interest: Continuation funds present new challenges and potential conflicts of interest for Limited Partners and the Direcotrs of the General Partner/s. There is no one-size-fits-all template. Every transaction is unique and must be avaluated on its own merits. For example, has the fund fully paid carry, or is there some being rolled over? How much concentration risk, in a particular company or sector, are you willing to accept? At what point do you decline? GP’s must also consider risk management and create rules for the fund.
2. Fee structure: Compared to a typical private equity fund, the fees are generally lower, and the preferences are likely to be more in the LPs’ favour. For example, there may be lower carry until it achieves its target internal rate of return (IRR) of perhaps 12% or 15%.If the continuation fund underperforms, the LPs may end up paying a higher carry than had the asset remained in the broader portfolio.
3. Valuation of the transferring asset/s. A fair price needs to be determined for assets to be transferred, but who is best placed to do this as both funds have the same fund manager who manages the valuation there a clear conflict of interest. To prevent this there are several considerations that can be taken.

• Independent valuation of the assets.
• Separate GPs for both funds so the directors can act in the best interests of their LPs.

For each of the above considerations, it is vital that they are given due consideration and discussion by the relevant Board of Directors prior to deciding on proceeding. However, with the explosive growth in continuation funds over the last 18 months, the industry needs to catch up to mitigate the risks.While the industry catches up, and as long as Mangers are able to utilise the use of Continuation Funds to create value to their Limited Partners, then they will continue to be used as a valuable tool when constructing and optimising portfolios.

How can we help?

If you’re considering setting up a fund, don’t hesitate to speak to our team at Altum. We are leaders in alternative asset administration and can provide you with the expertise and guidance you need to make informed decisions. Contact Matthew today to learn more about how we can help you achieve your goals.