Non-public fairness (PE) exit methods have tailored and developed previous the times of easy IPO runways and fast M&A turnarounds to incorporate continuation funds. The backdrop of low financing prices that inspired report transaction volumes, speedy fund rotations, and regular exit alternatives have evaporated during the last 5 years. In at present’s high-rate setting, exit choices have narrowed, financing has change into costlier, and holding intervals have lengthened. Final yr, common buyout holding intervals rose to six.7 years from a two-decade common of 5.7 years with the exit backlog now larger than at any level since 2005, in line with McKinsey analysis.
Enter the continuation fund, which has quickly moved from area of interest to mainstream, providing alternative to many buyers whereas inviting warning from others. The emergence of continuation funds displays a structural evolution in non-public fairness moderately than a brief adjustment. These funds, a comparatively new addition to the PE ecosystem, allow liquidity in a capital-constrained world whereas testing the boundaries of transparency and governance.
Understanding Continuation Funds
A continuation fund permits a PE agency to switch a number of portfolio property from an present, maturing fund into a brand new car, usually managed by the identical basic accomplice (GP). Current restricted companions (LPs) can both money out or roll them into the brand new construction, whereas new buyers can purchase stakes in mature, high-performing property with shorter holding intervals.
The marketplace for continuation funds has expanded rapidly. In 2024, 96 such automobiles have been recorded, up 12.9% year-over-year, representing 14% of all PE exits. Single-asset continuation funds, just like the $3 billion Alterra Mountain Firm deal, underscore their rising scale. Analysts at Greenhill & Co. predict that continuation funds may account for 20% of PE exits within the coming years, pushed by a maturing secondary market and difficult exit environments.
Why the Rise?
All of this has slowed strategic M&A. In 2023, international M&A recorded its lowest stage in a decade, underscoring the post-pandemic slowdown in dealmaking. World PE exit depend declined to three,796 from the 2021 peak of 4,383. Whereas off its highs, international PE dry powder remains to be round $2.5 trillion as of mid-2025, and the stress to deploy capital stays excessive whilst exit channels tighten. A number of forces underpin the latest proliferation. Amongst them: a scarcity of conventional exit paths, a looming maturity wall, and a necessity for LPs to unencumber money.
First, rising financing prices have constrained leveraged buyouts and widened the bid-ask hole in M&A offers. Continuation funds permit managers to retain high-conviction property and supply buyers with liquidity choices. The approaching maturity wall is one other issue. Greater than 50% of PE funds at the moment are six years or older, with 1,607 funds set to wind down in 2025 or 2026. Continuation funds permit corporations to increase worth creation with out compelled gross sales.
Lastly, these funds align with investor demand for flexibility. LPs can exit for rapid liquidity or roll over to chase future upside. New buyers achieve publicity to confirmed property with decrease blind-pool danger. Continuation funds boast a 9% loss ratio in comparison with 19% for buyouts, providing higher risk-adjusted returns.
The Advantages: A Win-Win-Win?
Proponents argue that continuation funds profit all events concerned: GPs, present LPs, and new buyers. For GPs, this extension permits them to proceed managing high-performing property, thereby producing continued administration charges and carried curiosity.
LPs achieve liquidity with out sacrificing potential upside, whereas new buyers entry mature property with a clearer path to returns. Current evaluation suggests continuation funds have outperformed buyout funds throughout all quartiles by way of multiple-on-invested-capital (MOIC) whereas additionally demonstrating decrease loss ratios.
Empirical proof helps their enchantment. Morgan Stanley discovered that upper-quartile continuation funds achieved 1.8x MOIC, in contrast with 1.6x for comparable buyout funds. Sector-specific examples, corresponding to Lime Rock Companions’ use of continuation constructions in power property, illustrate how managers can prolong worth creation by means of market cycles. The corporations have utilized continuation funds to increase their possession of property in much less favored basins, betting on future market shifts. This flexibility can flip a superb funding into a fantastic one, particularly when market timing is suboptimal.
Dangers and Governance Challenges
Regardless of their advantages, continuation funds have raised governance and valuation considerations. When GPs act as each vendor and purchaser, conflicts of curiosity are inherent. Buyers have raised eyebrows on the nature of those transactions, with critics likening them to round financing constructions if not fastidiously ruled. For a deeper understanding of this dynamic, learn CFA Institute Analysis and Coverage Heart’s report Continuation Funds: Ethics in Non-public Markets.
Transparency in valuation can also be important. LPs should belief that the acquisition value for transferred property displays truthful market worth. Many corporations tackle this by participating third-party monetary advisors for unbiased opinions or conducting auctions to make sure market-driven valuations. But, LPs usually lack the assets to totally vet these offers, and the concentrated danger of single-asset funds (vs. diversified secondary funds) can deter rollovers.
Compounding these considerations, the 2024 Fifth Circuit Court docket of Appeals determination to vacate parts of the SEC’s Non-public Fund Advisers Rule eliminated necessary fairness-opinion and disclosure necessities for continuation funds. This ruling reduces necessary reporting necessities, doubtlessly rising battle dangers as GPs face much less regulatory oversight but in addition permits for sooner transaction execution. It additionally will increase the onus on buyers to carry out thorough due diligence underscoring the necessity for voluntary and strong governance.
Greatest Practices for Buyers
For these navigating continuation funds, a number of finest practices can mitigate dangers and improve outcomes:
- Guarantee Impartial Valuation: : Demand third-party valuations from respected advisors, corresponding to Houlihan Lokey or Evercore, to confirm truthful asset pricing and search public sale processes the place possible. LPs ought to request detailed pricing methodologies and comparable transaction information.
- Align GP and LP Incentives: Require GPs to roll over 100% of their funding and negotiate carried curiosity and management-fee constructions that stability long-term alignment with investor safety.
- Assess Focus Danger: Single-asset continuation funds can introduce heightened publicity; buyers ought to evaluate their risk-return profiles in opposition to diversified secondary funds and conduct stress exams below opposed market circumstances.
- Negotiate Governance Early: LPs ought to negotiate continuation fund phrases throughout preliminary fund formation, setting clear expectations for pricing, governance, and LP choices. Set up LP veto rights or advisory roles at preliminary fund formation to make sure affect over future continuation transactions.
- Leverage Specialist Experience: Have interaction advisors skilled in secondary and GP-led transactions to evaluate valuation methodologies, cash-flow fashions, and regulatory implications.
- Monitor Submit-Transaction Efficiency: Require clear, periodic reporting on operational and monetary metrics to verify that prolonged holding intervals generate incremental worth.
- Have interaction in Lively Dialogue: Foster open communication with GPs to deal with considerations about conflicts or transparency. Take part in LP advisory committees to affect governance and guarantee accountability. Lively engagement can deter self-dealing and promote truthful outcomes.
The New, New PE Regular
For buyers, success on this setting relies upon much less on the structural novelty of the car and extra on the rigor of its oversight. The lesson from each the zero-rate growth and the present high-rate adjustment is obvious: in non-public markets, worth creation endures solely when alignment, transparency, and self-discipline do.
