Continuation Funds: A Transformative Force in Private Equity

Written by: Luis Miguel Zuluaga - Vice President at Intesa Sanpaolo Luxembourg / Founder #StructuredFinanceCorner

December 2024

Continuation Funds, also known as Continuation Vehicles (CVs), have become a pivotal tool in the private equity landscape. While some perceive CVs as a novel financial innovation, their roots stretch back to 2012 when they were firstly known as “Fund-Level Restructuring.” Initially, these vehicles served as a means for General Partners (GPs) to house tail-end assets that were challenging to sell or  to avoid realizing losses in their funds by selling these companies at low valuation multiples.

Fast forward to the 2020s, the narrative surrounding CVs and its rationale has shifted dramatically. What was once seen as a last and shadowy resort for underperforming assets is now a sought-after strategy to retain and develop crown jewel portfolio companies without disrupting the typical lifecycle of a Fund (1yr fundraising+5yrs investing +5yrs harvesting). Retention of these high-performing assets let GPs to continue the deployment of proven value creation strategies for an extended timeline.

But What Is It Exactly a Continuation Fund?

In simple terms, a Continuation Fund is created when a sponsor establishes a new fund to roll an existing fund’s standout asset into the new vehicle, which will also be controlled by the sponsor. This enables the sponsor to keep control of the asset, ensuring continued value creation while providing liquidity options for Limited Partners (LPs).

The Rise of Continuation Funds

Macroeconomic volatility, geopolitical uncertainty, and underperformance of certain sectors have made traditional exits—via M&A, IPOs, or dividend recaps—less predictable and harder to execute. CVs, along with tools like NAV loans, emerged as creative solutions for providing liquidity to LPs during challenging market periods.

Interestingly, the appeal of CVs extends beyond challenging times. In 2021, a common record year for both M&A and private equity-backed transactions, CVs proved their enduring relevance, suggesting that they are no longer a fallback option but a proactive choice by GPs who believe in the continued growth potential of their top-performing assets.

However, the increasing use of CVs and market complexity, these transactions demand a clear and compelling thesis from GPs to justify this approach to LPs. Transparency is essential to ensure alignment of interests and to mitigate concerns over potential conflicts, such as metric enhancement for GPs at the expense of LPs.

 Key Considerations for Continuation Funds

For a CV to succeed, the rationale must be sound. According to Eneasz Kadziela, CFA, CAIA , Deputy CIO and Head of Private Equity at New York City Comptroller’s Bureau of Asset Management, who gave an interview in PEI September 2024 Edition, the following criteria are critical:

1. Extended Development Horizon: The portfolio company needs more time to achieve its value creation objectives, justifying an extended holding period of five years or more.
2. Investment Capital Requirements: The company requires additional capital that the existing fund cannot provide, necessitating fresh commitments from new LPs in the CV.
3. Sponsor Expertise: The current GP must demonstrate that they are the best entity to continue stewarding the asset, showcasing a proven ability to add value. Often reflected in the financial and operational metrics of the asset to be rolled-over.

Failing to meet one of these benchmarks can raise red flags among LPs, potentially harming the GP’s reputation – an unvaluable asset in the financial industry

Benefits of Continuation Funds

When properly structured, CVs can deliver significant advantages to the different parties:

For Existing LPs:

• Liquidity: Allows some LPs to cash-out on their investments and meet the financial obligations or commitments they may have, such as fund pension plans, execute portfolio rebalancing or re-deploy capital elsewhere
• Extended Value Creation: Enables non-cash-strapped LPs to retain high-performing assets, benefit from continued value creation and cash-out the investment at a higher value

For New LPs:

• Investment Opportunity: Provides access to well-performing assets with a demonstrated value creation strategy and generally shorter holding periods. A recent study performed by Professor Oliver Gottschalg at HEC Paris in collaboration with investment firm Evercore – “Continuation Funds: Performants and Determinants” - highlighted that while single-asset CVs have similar TVPI ratios as those of typical buyout funds (1.5x), when it comes to return dispersion CVs proved to have a lower value, yielding a higher Sharpe-Ratio. Put it simply, on average CVs offer the same expected return at a lower risk. Interesting, isn’t it?

For GPs:

• Extended Value Creation: As it is the case for existing LPs who want to keep the assets for longer, it goes the same way for GPs, who can have the flexibility to hold assets longer and realize their full potential.
• Business Continuity: Helps maintain the natural private equity business cycle (fundraise, invest and harvest), independent of market conditions. Additional fundraising will be done to raise capital commitments in the continuation for follow-on investments,  ensuring business continuity and fees collection. Keeping a dynamic business cycle is quintessential for the franchise of PE houses
• Enhanced Metrics: Execution of successful CVs transactions will improve fund performance metrics (e.g., DPI, TVPI), which are extremely valuable for marketing purposes during fundraising stages for the sponsor’s new funds
• Liquidity for Sponsors: CVs may provide some liquidity via a crystallization (partial or total) of carried interest in the legacy fund.

Navigating Challenges

Despite their advantages, CVs present complexities that require careful management:

• Transparent Decision-Making: Since some conflict of interests derive from current LPs not rolling into the new CV, in order to protect their reputation and legitimacy, GPs should provide LPs sufficient time and information to make informed decisions about rolling or selling their stakes. GPs do not want to look abusive with their LPs
• Fair Price Discovery: Involves engaging diverse buyer types, not just secondary investors, to ensure equitable valuations.
• Conflict Mitigation: Clearly address potential conflicts arising from the structuring of the CV, such as: carry crystallization or metric enhancement
• Governance Protections: Avoid pre-authorizing CVs without independent Limited Partnership Advisory Committees (LPAC) oversight, which could undermine LP interests and deteriorate confidence

Conclusion

The evolution of Continuation Funds reflects the adaptability of the private equity industry. Once viewed with skepticism, these vehicles have matured into powerful tools for navigating complex financial landscapes, creating win-win scenarios for all stakeholders—when structured with care and transparency.

Yet, their growing use calls for reflection: Are they being used to genuinely unlock long-term value, or are they at times a shortcut to manage liquidity and metrics? The answer lies in the intentions of GPs and the vigilance of LPs, underscoring the importance of trust, alignment, and shared vision.

Ultimately, the true measure of their success will be measured not by enhanced metrics but by the lasting relationships they strengthen and the sustainable value they create.

Note: In order to promote best industry practices, the Institutional Limited Partners Association (ILPA) , published its guidance on CVs: Continuation Funds: Considerations for Limited Partners and General Partners.

Special thanks to: Sihan Chen and Fund Financer News and SecondaryLink for its support in publishing this article