Holding Onto Winners: The Quiet Revolution of Continuation Funds in 2024

Did you know that continuation funds accounted for 90% of GP-led transactions in the first half 2024, up from 88% in 2023?

That’s not just a small uptick. There’s been growth over the last decade and it’s a clear sign that continuation funds are becoming a go-to strategy in private equity.

But here’s the thing: continuation funds aren’t just about giving investors an exit. They’re a lot more versatile than that.

Let’s dig into the main details. Continuation funds let General Partners (GPs) hold onto great investments for longer, giving them more time and resources to unlock even more value.

At the same time, they offer Limited Partners  (LPs) choices: cash out if they need liquidity, or stay invested to ride the wave of future growth.

But it’s not all smooth sailing. Continuation funds come with their own set of challenges which we’ll discuss in more depth soon.

GPs must carefully balance the needs of existing LPs and incoming investors, a dynamic that can create conflicts of interest if not managed transparently.

Meanwhile, accurate valuation of assets is critical, especially in a market where volatility and economic uncertainty can skew pricing and expectations.

Before we delve deeper, please note that this blog is not financial advice.

It is an exploration of how continuation funds are evolving and influencing the secondary market in 2024, based on the latest reports by industry leaders. I hope you find it useful.

Understanding Continuation Funds

A continuation fund is a type of secondary transaction where GPs transfer assets from an existing fund into a new fund.

Imagine a renewable energy company doing really well. Well, rather than selling it off, the firm sets up a continuation fund to hold onto the asset, let existing investors decide if they want to exit or reinvest, and bring in fresh investors to fuel the next stage of growth.

It’s important to remember that GPs play a critical role by identifying high-performing assets, structuring the fund, and managing the transition, while balancing the interests of both existing and incoming investors.

Limited Partners therefore get flexibility, the option rolling over their investment, cashing out, or a combination of both.

Unlike the traditional private equity model, which often bakes in mandatory liquidation at the end of a fund term, continuation funds provide an alternative liquidity option.

Continuation funds typically focus on retaining high-performing or trophy assets, offering both existing LPs and new investors an opportunity to invest in mature portfolio companies with clear upside potential.

To give a real-world example in the news recently, Trustar Capital has established a $1 billion continuation fund to maintain its controlling stake in McDonald's operations in mainland China and Hong Kong.

The move allows Trustar to provide liquidity to existing investors while continuing to support the expansion of McDonald's in the region.

The continuation fund will provide an exit for some of Trustar's private equity limited partners, according to Reuters. 

Key Drivers of Growing Interest in Continuation Funds

Continuation funds have existed in one form or another for decades. But the trend towards increasing adoption has exploded over the past five years.

The year 2021 proved to be a banner year of around $68 billion in deal value, representing a 750% increase over the preceding five years. But what has triggered this growth?

1. Liquidity Constraints: Limited partners facing liquidity challenges are increasingly turning to the secondary markets to rebalance allocations and adjust their investment distributions. Vestlane actually plays a crucial role in investor onboarding and ensuring compliance in these secondary market investments. 

2. High-Quality Assets: GPs aim to retain their top performing assets beyond the life of the original fund, ensuring maximum value realization, or squeezing every penny, whenever they hit upon a winning asset. 

3. Innovative Structures: Continuation vehicles offer flexible solutions for institutional investors, including co-investments and deferred payments. This additional room to manoeuvre can be tough to resist when the regulatory and market sands are shifting under the latest economic or geopolitical headwinds.

The Role of Continuation Funds in the Secondary Market

Market Growth and Transaction Volume

The secondary market has experienced record-breaking transaction volume in 2024, with continuation fund transactions representing an ever-increasing share.

According to a recent report by Jefferies, the secondary market saw a 58% increase in transaction volume in H1 2024 compared to the same period in 2023.

GP-led secondary deals accounted for $28 billion, driven by single-asset continuation vehicles (SACVs) and multi-asset continuation vehicles (MACVs).

Structural and Operational Dynamics

Continuation funds typically arise from GP-led secondary transactions, in which assets from an original fund are transferred to a new fund, often with the same GP managing both sides of the transaction.

Meanwhile, LPs vote through an advisory committee to approve the transaction, ensuring alignment of interests while avoiding any potential conflicts that may arise.

Single-Asset vs. Multi-Asset Continuation Vehicles

SACVs focus on a single, high-performing asset. These funds have gained traction due to their simplicity and appeal to buyers seeking clear, easily communicable valuation metrics and propositions.

MACVs involve a broader portfolio, allowing GPs to provide liquidity across multiple assets.

They are often favored by large-cap sponsors managing complex allocations, but may prove cumbersome for smaller stakeholders.

What to Watch Out for with Continuation Funds

As continuation funds gain increasing prominence, they face a range of challenges and questions that could shape their future use.

Concerns about perceived conflicts of interest, and the potential for heightened regulatory scrutiny abound, as deals become increasingly complex.

Additionally, the significant costs associated with establishing and managing these funds may pose barriers, particularly for smaller private equity firms.

Valuation and Fairness Opinion

Valuation plays a pivotal role in the success of continuation fund transactions.

To ensure fairness, GPs often engage third-party advisors to provide a fairness opinion, which helps to establish transparency, and safeguards both existing LPs and new investors.

Vestlane can actually help solve security and efficiency challenges by centralizing data, automating compliance, and facilitating clear communication among GPs, LPs, and investors.

Alignment of Interests

Continuation funds are built on proper alignment of interest between GPs and LPs.

Carried interest from the original fund is often reinvested into the continuation vehicle, ensuring GPs still have ‘skin in the game’ and are properly incentivized to maximize performance.

Regulatory and Market Considerations

Regulators are paying closer attention to GP-led transactions, given their complexity and potential for misalignment.

As continuation funds grow in prominence, private equity firms must adhere to ever-evolving standards for due diligence and transparency.

Potential Conflicts of Interest

The dual role of GPs in managing both the existing fund and creating the new fund can allow for potential conflicts of interest.

Best practices call for the involvement of an independent, non-partisan advisory committee to address conflicts of interest.

The Institutional Limited Partners Association (ILPA) released its Continuation Funds: Considerations for Limited Partners and General Partners best practice guide back in 2023.

It was released in response to the growing number of continuation fund transactions happening in private equity. 

The guide addresses several critical aspects, including:

1. Engagement with LPs: ILPA emphasizes the importance of involving LPs early in the decision-making process. GPs are encouraged to engage with LPs transparently, ensuring they have a voice and sufficient time to evaluate proposed transactions.
   
   
2. Disclosure Requirements: GPs should provide detailed and standardized information to LPs, including the rationale for the transaction, conflicts of interest, terms of the deal, and the process used to determine valuations.
   
   
3. Process Timing: The guidance stresses the need for a clear timeline that allows LPs to assess their options and seek independent advice, particularly for opting in or out of the transaction.
   
   
4. Legal and Structural Considerations: ILPA outlines best practices for structuring continuation funds, highlighting the importance of managing conflicts of interest and ensuring that terms align with the interests of both LPs and GPs.

What’s the Upside? Benefits for Stakeholders

General Partners

Continuation funds allow GPs to retain high-performing assets that have substantial upside potential, extending their investment horizon to fully capitalize on growth opportunities.

They also allow GPs to reset holding periods and optimize fund structures, ensuring better alignment with strategic objectives.

Additionally, these funds offer access to new investors, enhancing capital availability and increasing flexibility in structuring transactions to suit diverse investment goals.

Amid an ongoing liquidity crunch, the secondaries market, most notably continuation funds, have provided a lifeline in the form of exit liquidity.

Limited Partners

Continuation funds offer limited partners liquidity options that enable them to rebalance portfolios or redeploy capital as needed.

They also provide the opportunity to continue participating in mature, high-quality assets with proven performance.

Furthermore, competitive market conditions contribute to increased pricing transparency, ensuring fair valuations and alignment with investor expectations.

The Secondary Market as a Whole

Continuation funds drive growth in the secondary private equity market by increasing transaction volume and diversifying deal types, while adding greater sophistication in pricing and fund structures.

Additionally, these funds attract broader participation from institutional investors and hedge funds, expanding the market's reach and liquidity.

Securing the Next Chapter in Private Equity

The rise of continuation funds certainly marks a significant change in the private equity and secondary market landscape.

By offering liquidity solutions and preserving upside potential, these vehicles are becoming more indispensable for general partners and limited partners alike to maximize return on investment.

However, as the market grows, it is critical for stakeholders to remain vigilant about potential conflicts of interest and increasingly-demanding regulatory expectations.

With proper governance and adherence to best practices, continuation funds are poised to play an even greater role in shaping the future of private equity. 

Digital platforms like Vestlane offer modern tools to help private equity influencers work their way into future investment trends and changes.

In fact recently, we announced that fund managers can now use Vestlane to onboard secondary investors with ease.

This feature lets you digitalize the onboarding and KYC processes for secondary investors, all from your Vestlane dashboard.

From automated fund subscriptions and closings that reduce months of manual work to days, to compliance tools that allow for audit readiness across jurisdictions with KYC/AML, KYB, and KYA support, our solution also addresses other real pain points.

For example, if I point you to Vestlane’s Shared Workspace, you’ll see that it centralizes processes and creates a single source of truth for teams and service providers.

The Investor Wallet streamlines the experience for repeat investors, enabling quick subscriptions and expanding global LP access.

By providing these innovative solutions, Vestlane gives fund managers and investors the ability to navigate the complexities of continuation funds and much more, ensuring operational efficiency, regulatory compliance, and enhanced trust. Find out more by booking a demo and thank you for reading.