Continuation Funds: Considerations for Investors and Fund Managers

With continued investor demand for liquidity within the private sector, continuation funds remain a growing alternative for fund managers. However, there are some considerations they need to take into account.  

Key Takeaways 

• Continuation funds offer fund managers a way to extend the life of high-performing assets while providing liquidity options to investors. 
• These vehicles introduce potential conflicts of interest, particularly around valuation and carried interest. 
• Fund managers must balance fiduciary duties to both legacy and new investors, which can create pricing challenges. 
• Best practices like transparency, LPAC approval, and fairness opinions can help build investor trust and mitigate concerns. 

What are Continuation Funds and How Do They Work?  

Continuation funds allow for a departure from the traditional private equity model liquidity restraints and extend the holding period for better producing investments which could result in optimizing the upside for legacy investors.  

The investment will continue to be held and managed by the fund manager while providing interim liquidity by allowing investors the option to “roll” their interests into the new vehicle at a certain price point or “cash out” and put the decision making in their hands.  

Key Considerations and Potential Conflicts of Continuation Funds  

Investors should keep in mind, however, that this seemingly attractive option does not come without conflict-of-interest concerns. Some challenge the structure of how these are facilitated and the use of subjective valuations to facilitate an exit for the legacy fund that will not carry certain representations to the newly formed continuation fund; particularly with its crystallization of carried interest and price point.  

These issues underscore the importance of transparency and governance in structuring continuation fund transactions.

Fiduciary Duties and Pricing Challenges of Continuation Funds  

Fund managers are expected to carry out their fiduciary duties by performing in the best interest of the legacy investor base as well as the new investor base for the same investment while also being cognizant of tax and regulatory considerations.   

To maximize the goals of the investors, fund managers are expected to exit at the highest feasible price for their legacy investors while also purchasing the investment in the continuation vehicle at the lowest price for these investors, which poses a real challenge.   

Building Investor Confidence  

There are a handful of ways fund managers can mitigate or attempt to ease investor concerns, including: 

• Maintaining full investor transparency including the expense sharing arrangement 
• Obtaining limited partner advisory committee approval 
• Rolling more of the exit proceeds from the legacy fund into the continuation vehicle 
• Including tiered or deferred carried interest economics in the continuation vehicle to remediate post downturn risks of investment performance and alleviating the reset of manager incentive compensation 
• Obtaining an independent fairness opinion with regard to the price point of the transaction 

These steps can help reassure investors and demonstrate a commitment to fairness and fiduciary integrity.  

The Future of Continuation Funds  

There will always be differing viewpoints on the ethical and effectiveness of continuation funds and its pros and cons, but it has not hindered its popularity as a viable secondary outlet for investor liquidity.  

If you're a fund manager or investor considering continuation funds as part of your strategy, now is the time to act. Reach out to our team to learn how to structure these vehicles effectively and responsibly, while maximizing value for all stakeholders.