What is Continuation Funds? Why Becoming So Popular?
Continuation funds are specialized investment vehicles used in private equity and other private capital markets. They allow General Partners (GPs) to extend the holding period of certain assets beyond the lifecycle of the original investment fund. Instead of selling the assets outright, GPs transfer them into a new fund, typically backed by existing Limited Partners (LPs) and sometimes new investors.
Key Features of Continuation Funds:
Purpose: They provide GPs with more time to manage high-potential assets that need additional capital or time to realize full value. They offer LPs a choice: cash out their investment early or "roll over" into the continuation fund to benefit from the asset's longer-term growth.
Structure: A continuation fund is created when one or more assets are moved from the original fund (often near the end of its lifecycle) into this new vehicle. This process is often referred to as a GP-led secondary transaction, where the GP takes the lead in structuring and negotiating the deal.
Types of Assets: Single-asset continuation funds focus on one high-value asset. Multi-asset continuation funds include a portfolio of assets.
Why Use Continuation Funds?
For GPs (General Partners):
Extend Timeframes: Allows them to hold onto promising assets without being forced to sell when the original fund ends.
Crystallize Carry: GPs can earn carried interest (performance fees) by realizing gains in the transfer process while continuing to benefit from future performance.
Maintain AUM: By retaining control of high-value assets, GPs can keep assets under management, which is important for firm growth.
For LPs (Limited Partners):
Liquidity: Existing LPs can choose to sell their stake for immediate cash, addressing their liquidity needs.
Optionality: LPs who believe in the long-term potential of an asset can reinvest in the continuation fund and benefit from additional growth.
Benefits of Continuation Funds:
Unlock Value: High-potential assets get additional capital and time to reach peak value.
Flexibility: LPs have more options to exit or reinvest, depending on their goals.
Improved Liquidity: Continuation funds help ease liquidity constraints for both LPs and GPs, especially in tight markets.
Criticism and Skepticism:
"Sell-to-Yourself" Transactions: Critics argue that continuation funds may allow GPs to move underperforming or mediocre assets into new vehicles, essentially rolling over problems.
Transparency Concerns: Some LPs worry about whether the valuation and terms of the transaction are fair.
Potential Misuse: There’s a risk that GPs could overuse this tool, leading to limited LP willingness to reinvest.
Why Are Continuation Funds Popular Now?
Exit Challenges: With slow IPO markets and fewer M&A opportunities, GPs struggle to exit investments through traditional routes. Continuation funds offer an alternative.
High-Quality Assets: GPs are increasingly using them for their best-performing assets, not just to manage "zombie portfolios."
Liquidity Crunch: Rising interest rates and economic uncertainty have increased demand for tools that provide faster access to cash for LPs.
Example of a Continuation Fund:
Suppose a private equity fund invested in a fast-growing tech company in 2015. By 2025, the original fund is nearing the end of its life, but the tech company still has significant growth potential. Instead of selling it to a third party, the GP creates a continuation fund and transfers the tech company into it. Existing LPs can either cash out or roll their stake into the continuation fund, while new LPs can also invest in the asset.
Q: Why are continuation funds becoming so popular?
A: More managers than ever are turning to continuation funds because they offer a way to grow promising assets rather than holding underperforming ones. Positive performance data from 2024 highlights their ability to generate value, which appeals to both GPs (General Partners) and LPs (Limited Partners).
Q: How many continuation funds closed in 2024, and how does it compare to previous years?
A: By December 11, 2024, 65 continuation funds had closed, breaking the previous record of 57 in 2023. The total capital raised, $36 billion, is close to the 2021 peak of $38 billion.
Q: Why are more GPs turning to continuation funds for the first time?
A: Continuation funds allow GPs to extend the holding period of high-performing assets, maintaining AUM (Assets Under Management) and crystallizing carry. This shift addresses liquidity challenges in a market where exits have slowed significantly since interest rates began rising in March 2022.
Q: What is driving the shift from multi-asset to single-asset continuation funds?
A: In 2024, single-asset funds accounted for nearly half of the transactions (33 out of 65), marking a significant shift from 2021, where multi-asset funds dominated. This change reflects a move away from addressing "zombie portfolios" and towards nurturing high-potential, single assets for future growth.
Q: What benefits do LPs see in continuation funds?
A: LPs appreciate the accelerated liquidity that these funds provide. According to Joseph Smith, Co-Head of the Private Equity Funds Group at Schulte Roth & Zabel, continuation funds help LPs receive distributions sooner, which is critical in the current liquidity-constrained environment.
Q: What concerns do LPs have about continuation funds?
A: LPs evaluate continuation funds with caution, often questioning why this path is preferred over a conventional exit. Jennifer Choi, CEO of the Institutional Limited Partner Association, emphasizes the importance of understanding why a fund is being transacted early and whether it’s the best course of action for a high-quality asset.
Q: Which regions saw the most first-time users of continuation funds in 2024?
A: North America led the growth, with 34 managers closing their first continuation funds in 2024, followed by Europe with 20.
Q: Who are the top players in continuation funds by capital raised?
A: As of December 2024, the top firms by aggregate capital raised include:
Clearlake Capital Group (US): $8 billion across 5 funds
Hellman & Friedman (US): $5 billion across 2 funds
Leonard Green & Partners (US): $4.7 billion across 3 funds
Q: What are some of the largest continuation funds of all time?
A: Notable single-asset continuation funds include:
CD&R Value Building Partners I (2021): $4.0 billion by Clayton Dubilier & Rice
GIP Gatwick Airport Continuation Fund (2019): $3.9 billion by Global Infrastructure Partners
For multi-asset funds:
Hellman & Friedman VII Continuation Fund (2020): $5.0 billion by Hellman & Friedman
Q: How will continuation funds shape the private equity landscape going forward?
A: Continuation funds offer GPs and LPs shorter investment horizons (3-5 years vs. the traditional 10 years) and the potential for higher returns. As more unicorns emerge from these vehicles, they may become a cornerstone in building billion-dollar companies.
Disclaimer: This analysis is based on general market trends and should not be construed as financial or investment advice. It is essential to conduct thorough research and consult with qualified professionals before making any real estate decisions.