Continuation funds - some key considerations

When continuation funds are used

Typically, continuation funds are used in two situations:

  • where a manager is unable or unwilling to realise assets at (or near) the end of a fund’s term, perhaps because those assets are problematic or distressed and there are no, or few, willing buyers prepared to pay the price being sought; or
  • where a manager (and investors) wish to maintain exposure to certain assets, for example where they are of high quality or have reached maturity and may be highly income generative

A new fund vehicle is created which purchases those assets from an existing fund by raising new capital – either from new investors or from existing investors. Either way, they can provide liquidity to investors in the existing fund who are seeking it which may not otherwise be available.

With private markets facing liquidity challenges in a number of sectors, limited partners (LPs) can find themselves waiting longer for returns on some portfolio assets. Where a conventional fund term extension is no longer the right option, a continuation fund or other restructuring may be. Continuation funds are nothing new, but we are seeing an increase in their use, as some investors grapple with liquidity and high quality assets are perhaps not as readily available as they once were.

How continuation funds work

Existing LPs may be given the opportunity to “roll over” their interest in the underlying investment(s) into the continuation fund or cash out and take gains (or losses) from the realisation. A rolling LP makes a capital commitment to the new vehicle – which is effectively contributed in kind at the outset with its share of the assets being transferred in. The continuation fund can also be offered to new LPs who make capital commitments to the continuation fund, thereby providing the cash to generate liquidity for LPs in the existing fund who elect to sell. Commonly a buffer for anticipated follow-on capital is needed, particularly for turnaround assets or those which will benefit from capital expenditure or a bolt-on strategy, as well as ongoing costs of the continuation fund.

The terms of a continuation fund are typically negotiated extensively between the sponsor and the participating LPs, often reflecting asset-specific issues. As expected, manager economics and investor protection also provide key areas of focus, as participants look to achieve a better alignment of interests moving forward.

Why set up a continuation fund

A continuation fund is a useful tool which can provide various benefits to general partners (GPs) and LPs. They offer flexibility for GPs looking to extend hold periods for assets where they are unable to realise them at optimum value in the short term and/or have potential for future upside. The GP will continue to manage the investment and may benefit from ongoing fees and carried interest (see below). The existing LPs benefit from a liquidity option (full or partial). If they choose to roll over their interest, they may benefit from a continued exposure to good assets and the opportunity to realise value from a longer-term investment. In addition, LPs have clear visibility on pre-identified assets, eliminating the blind pool risk they would otherwise face by making a new primary commitment elsewhere.

Some key issues to consider

Whilst there are many benefits to a continuation fund, there are a number of challenges in structuring them. We have noted below four key areas for consideration for participants, with a more in-depth view on conflicts of interest at the end of this note.

Conflicts - a closer look

For more information

To learn more about the team please visit our private funds or financial services regulation webpages.

In this note:
1 – ‘LPs’ refer to limited partners and ‘GPs’ refer to general partners
2 – ‘AIF’ refers to alternative investment fund
3 – ‘CIS’ refers to collective investment scheme
4 ‘- AIFM’ refers to an alternative investment fund manager
5 ‘- GP’ refers to led secondary fund restructurings ILPA >

The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.

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