What Is a Continuation Fund in Private Equity?

Private equity firms manage investment funds that acquire and manage private companies, aiming to enhance their value before selling them. These funds typically have a finite life, often 10 to 12 years, after which they liquidate investments and return capital to investors. As funds mature, firms face decisions regarding remaining portfolio companies, particularly those performing well but nearing the fund’s designated holding period. This has led to continuation funds, designed to manage mature assets and offer investor flexibility.

Defining a Continuation Fund

A continuation fund is a new investment vehicle established by a private equity firm, the General Partner (GP), to acquire portfolio companies from an existing, older fund managed by that same GP. This is a GP-led secondary transaction, as the initiative originates from the fund manager. The primary purpose is to allow the GP to extend ownership and management of high-performing assets beyond the original fund’s lifespan, providing an alternative to a forced sale due to fund expiration.

A continuation fund offers liquidity options to existing Limited Partners (LPs) in the original fund and enables the GP to continue nurturing companies with significant growth potential. Instead of selling these companies on the open market, the GP transfers them to a new, dedicated fund. This new fund is typically structured as a single-asset vehicle or holds a highly concentrated portfolio. The legal structure generally mirrors a traditional private equity fund, including a new limited partnership agreement and advisory committee.

This mechanism allows the GP to avoid suboptimal timing for selling companies at a fund’s end, especially if market conditions are unfavorable or growth trajectory is steep. For LPs, it presents a choice: they can receive immediate cash for their interest or roll their investment into the new fund, maintaining exposure to the same companies under a new investment thesis. The process involves establishing a new legal entity for the continuation fund, which formally purchases the designated assets from the original fund. This transaction is typically facilitated by new capital from new investors.

Mechanics of a Continuation Fund Transaction

The process begins with the General Partner (GP) identifying portfolio companies within an existing fund that have performed well and have significant remaining growth potential. These are often mature investments with operational stability and profitability. The GP determines that selling these assets in the current market might not maximize their value or allow for future strategic initiatives.

Once target assets are identified, an independent, third-party valuation ensures a fair market price for the transaction. This valuation, often by reputable firms, employs methodologies such as discounted cash flow and comparable company analysis. It establishes a clear benchmark for the transfer price, ensuring transparency and fairness for all parties, particularly existing Limited Partners (LPs). This independent assessment is crucial for mitigating potential conflicts of interest given the GP’s dual role.

Following valuation, the GP presents existing LPs with options. LPs can “cash out,” selling their pro rata share of assets to the new continuation fund for immediate liquidity at the agreed valuation. Alternatively, LPs can “roll over” their investment, transferring ownership into the new continuation fund and continuing exposure under the new fund’s terms. Some LPs may also opt for a partial cash-out and partial roll-over.

To facilitate cash-outs for existing LPs and provide capital for new strategic initiatives, the GP raises new capital from new investors. These investors are typically secondary market funds, pension funds, or other institutional investors interested in acquiring mature, high-quality private equity assets. They provide the necessary capital to purchase the interests of LPs who choose to cash out. The new fund’s terms, including management fees (1.5% to 2.5% annually) and carried interest (15% to 20% of profits), are negotiated with these new investors and reflect current market standards.

The transaction requires extensive legal documentation, including a new limited partnership agreement, purchase agreements, and detailed disclosure documents for existing LPs. Regulatory compliance is also a significant consideration, ensuring adherence to securities laws. This comprehensive process ensures transparent asset transfer, providing existing LPs a clear exit while securing new capital and an extended investment horizon for the GP and portfolio companies.

Key Characteristics and Participants

Continuation funds typically focus on a narrow selection of portfolio companies, often one or two, representing high-performing, mature investments from an existing private equity fund. These assets are usually companies that have navigated initial growth phases and established strong market positions, consistent revenue streams, and predictable cash flows. The decision to transfer these assets is driven by their continued growth potential beyond the original fund’s life, suggesting a longer hold period can unlock additional value.

The General Partner (GP) plays a central role, acting as both seller from the existing fund and manager of the new continuation fund. Their primary motivations include extending management of successful investments to realize greater carried interest (typically 20% of profits after investors receive initial capital plus a preferred return). This structure also allows GPs to maintain control over strategic assets, avoid selling in unfavorable market conditions, and continue collecting management fees.

Limited Partners (LPs) from the original fund are key participants and are presented with a choice. Existing LPs who cash out benefit from immediate liquidity, allowing them to rebalance portfolios or meet capital distribution requirements. This provides a structured exit for otherwise illiquid investments. LPs who roll their investment into the new fund demonstrate confidence in the GP’s management and the portfolio company’s future prospects, recommitting their capital for a new investment period.

New institutional investors are crucial for funding the continuation fund, providing capital to buy out LPs who cash out. These new LPs, often including secondary funds, endowments, and pension funds, are motivated by the opportunity to invest in mature, de-risked assets with established performance records. They gain exposure to companies that have undergone significant value creation under GP management, potentially leading to faster distributions. Their participation also comes with a negotiated fee structure, including management fees and carried interest, aligning their interests with the GP’s long-term success.

Governance within continuation funds often includes an advisory committee, providing oversight and guidance. Asset valuation is a continuous process, with independent third-party valuations performed at key junctures to ensure transparency and fair reporting of asset values. Fee structures, including management fees and carried interest, are clearly defined within the new fund’s legal documents, reflecting terms agreed upon between the GP and new investors, and often incorporate a preferred return threshold.