This is a repost of my Capstone Project which was writen in 2024. A lot of the dynamics behind this project hasn’t evolved. Additionally, the market for Continuation Funds is still growing with no end in sight. This paper is relevant today as it was last year.

Continuation Funds: The Next Frontier

Introduction

In October 2023, while working in Goldman Sachs, I came across a very interesting private equity fund. The fund was nearing the end of it’s life cycle however it still had a few of portfolio companies still underneath it. This was quite perplexing as the fund had to soon return capital to it’s investors. However, I didn’t think much of it until I came across a paper published by Kobi Kastiel & Yaron Nili about the rise of Private Equity Continuation funds1. It captivated my attention and pushed me into a deep void of finance, law and general ethics. This paper serves as a primer into my extensive research into the private equity world and continuation funds. I intended to introduce the idea of continuation funds, the issues behind them and the dislike amongst the investment community for them. Continuation Funds have grown increasingly popular within the private equity space and now the most common type of secondary transactions led by private equity sponsors2. From 2017 to 2023, US Continuation funds deals have grown from $1.5bn to $6.5bn 3. In 2021, these transactions reached their highest volume in history, estimated at around $65bn in deal value representing a 750% increase since 20164. These statistics does give us a reason why it is important to look closely at Continuation funds. Additionally, I will introduce 4 solutions that are recently showing positive implications for this sub-asset category.

Issue Statement

How can private equity firms effectively navigate the complexities surrounding exits, including the emergence of continuation funds, to optimize returns and uphold their reputation? Specifically, how can they adeptly address the challenges posed by market dynamics, regulatory hurdles, and strategic considerations while fostering transparency, collaboration, and alignment among stakeholders? Furthermore, How are Private Equity firms managing continuation funds in a manner that helps boost investor’s confidence in the long run amist challenges in the global financial marketplace? Private Equity Firms To understand the Private Equity world in detail, we need to lay the foundation of what private equity firms do, how they function, who are their investors and what do they invest in. This foundation would help us dive deeper into the machine that is private equity. The Private Equity Model is as definfied as Private equity funds raise and pool money from investors to buy and sell companies, often financing the acquisitions with a significant amount of debt5. A Private Equity Firm is an investment firm that invests in private assets through Special purpose vehicles (SPV) called private equity funds. They are designed as investment partnerships that buy and manage companies before selling them. Private equity firms operate these funds on behalf of institutional and accredited investors. In effect, Private Equity firms act as General Partners (GPs) and the investors take on the role of Limited Partners (LPs). There are many types of private equity funds such as buyout, distressed, growth equity, secondaries, carve-outs and sector specialists6. Venture capital is also considered as private equity but venture capital invests in early stage start-ups versus private equity that invests in mature companies. Hence this paper will only consider private equity in the sense of mature companies. Private Equity firms also organise along various market capitalisation levels of firms such as large, middle and small capitalisation. Along with private equity firms, there are firms that exist on the debt side of transaction. These are called Private credit firms. They operate and structure in a similar fashion as private equity firms however, they serve as alternatives to traditional bonds. They offer increased flexibility and work in tandem with private equity firms from time to time. As of late, private credit funds have seen a recent surge in popularity for their simplicity and an alternative to bank loans. This popularity is a result of rising interest rates around the world however there are other alternative explanations as to their surge in popularity. This paper will not dive into private credit but it is considered an important pillar of the private assets world.
It is also important to understand how private equity firms get paid. Private equity firms are similar to other private investments when it comes to fees charged. They employ a 2 and 20 model derived from the hedge fund world, wherein they charge 2% management fees and 20% performance fees on profits achieved. Management fees are collected on the total Assets under Management (AUM) while performance fees are only collected from the profit achieved7. Some funds may have a hurdle rate clause which doesn’t allow for the firms to collect a performance fee unless a certain hurdle rate is achieved. This hurdle rate may be tied to popular indexes such as Standard & Poor’s 500 or Dow Jones Industrial Average (DJIA)8. We will look into fees as the paper progresses as this plays a very important role in the daily functioning of Private equity firms. Another aspect is to understand are the professionals employed at private equity firms. Private Equity firms consist of two sets of professionals, the financial engineers and the operators9. Private equity firms usually employ investment bankers with some deal experience as the financial engineers. They usually look at across all verticals and mostly care about the coachablity aspect of these individuals. On the other hand, private equity firms also employ management consultants and industry professionals as operators due to their experience dealing with issues in their particular industry verticals. However, this is not a rule set in stone. Private equity firms are known for their speed and prefer individuals who are able to make thoughtful decisions to help increase profitability of their portfolio companies. At the end of the day, private equity firms are paid based on their performance for growing investor capital. Hence, it is vital to their business model to hire the best talent possible. Now since we have a brief understanding of how private equity firms operate. We can look into the fund lifecycle from the formation till the end. This process will give us a better understanding of the continuation funds. Fund Lifecycle A Private Equity Fund Lifecycle can be divided into 3 parts: • Fundraising and Creation • Investing and Operating • Exits and Returns We will divide deeper into each part and provide more details about each aspect. Understanding these processes will help us in defining and identifying the problem this paper is gearing towards. As we dig deeper into each part, it is important to understand that some of these processes overlap with other funds that the private equity firm may have. The cycle is continuous in nature and serves to help run the private equity firm.

Fundraising and Creation

Fundraising is a critical function of a private equity firm. This step involves outreach to institutional and accredited investors to attract them to invest in their fund. It may seem trivial in the grand scheme of operations but private equity firms spend a lot of time fundraising for their funds. The industry has gotten a lot bigger than days of RJR Nabisco when KKR was the sole top player in the space10. Nowadays, if you are an institutional or accredited investor, you have a number of ‘barbarians’ that you can chose from. Hence, firms spend a lot of time wooing clients with research reports about performance from previous private equity funds (vintages) as well as negotiating terms regarding future investments. This is why a lot of investment banks with private wealth divisions are expanding their client base considerable to attract more accredited investors so that they are able to streamline their fundraising efforts. The industry also has a number of smaller private equity firms that focus on smaller companies in the mid-cap and small-cap space which have grown in popularity as well11. As a result, Private equity firms compete fiercely for investment allocations from institutions and accredited investors, making this function a critical component of their fund cycle. Creation of a new private equity fund is also critical but only in terms of operational manpower involved. Once the private equity firm has completed their fund raising goal of the new fund, a special purpose vehicle is created and capital commitment documents are sent to their LPs who pledged their investment for this new fund. Usually the creation and fundraising go hand in hand but at smaller firms with less history, fundraising is the first step to gain traction and then creation of the fund takes place. This is to avoid being underfunded and to make sure that they are able to reach their intended target size. Doing this also serves as a gauge for investor appetite into what the private equity firm is offering with their new fund12. For example, if a software focused private equity firm suddenly decided that they want to start a new fund that would invest in data center real estate. This would stray away from their focus and would make new and old LPs skeptical if they have enough expertise to invest in data centers. In effect, it would be wise for this firm to go fundraising first to entice LPs and explain their rationale behind this new fund. Once they have enough LPs then could move into the creation phase of the fund. The creation phase also involves the help of specialized lawyers who are focused in fund creation and management. It is important to select the best structure for the fund as it dictates the future of the fund for years to come. It needs to be flexible and functional which being tax efficient as well. Most large private equity firms have lawyers in house whereas smaller firms usually hire lawyers on a contract basis to keep expenses low for the LPs. This is because any lawyers fees are charged to the fund than the firm13.

Investing and Operating

Investing and Operating is the main phase where private equity firms shine. Private Equity firms source public or private companies based on their fund investment criteria. It is important to stay in line with the fund investment criteria as private funds are usually regulated. We will dive deeper into regulation later on in this paper as it plays a key role with our main topic. Sourcing companies to invest in is a considerable challenge at times which makes the task of investing even harder14. Additionally, a fund might even need to compete with other funds for the same company as well which makes investing a harder task. But once a company is identified as a potential target, the private equity firm would run calculations based on publicly available data about the company to come up with a purchase price for the company. This rough calculation serves as a basis for investment thesis for that company. This investment thesis along with the rough calculation and purchase price is then taken up to the Investment Committee of the private equity firm, where discussions are held to see if the investment thesis is sound and if it is worth pursuing a takeover of the company. If the investment thesis holds up in the investment committee, then the private equity firm signs a Letter of Intent (LOI) with the target company to purchase the company. However, this LOI is considered the first order of interaction with the target company. The LOI serves various roles but most importantly, it allows the target company to either respond positively by granting the private equity team access to selected internal documents that would help the private equity team to pinpoint an accurate price for the purchase of the target company or negatively by rejecting the LOI, which would be a sign that they aren’t interested in being acquired for the purchase price provided on the LOI. The target company additionally can employ a valuation firm to make sure that the private equity firm isn’t underpaying them. The target company also makes the private equity firm sign a non-disclosure agreement to make sure their internal company documents aren’t leaked out15. We won’t go much into details regarding this process as it tends to involve a lot of due diligence that is carried out by both parties. The goal is clear to both parties involved. The private equity firm is looking for a high functioning business with a good balance sheet for the right price and the target company is looking to get the right price for it’s shareholders. Once both parties agree on a price, the private equity firm now employs it’s financial engineering expertise to complete the leveraged buyout of the target company. We haven’t explained what a leveraged buyout means previously as this is a key factor to how private equity works and deserves a special section. Leveraged buyout is a process of purchasing an asset with the help of debt and equity. Debt is a key component of this process and is usually acquired in the form of bank loans. Additionally, this debt is taken out by the target company and not by the private equity fund. They will use the debt proceeds to paydown any existing debt and pay the shareholders of the company. In a way, the GP is changing the capitalisation structure of the firm. To fill the gap, equity is used to pay for the rest of the assets in the target company. This equity comes from cash that LPs had pledged to put in the private equity fund. In the early 1970s and 1980s, private equity firms used to buy companies with 25% equity and 75% debt. But nowadays, this number is closer to 40% equity and 60% debt. This debt component helps private equity firms achieve those high returns due to the leverage effect along with the tax benefit offered by debt. Over the life of the fund, the private equity firm will use profits from the operations of the business to pay down debt. This process in turn increases the amount of equity in the company that will be available to LPs once the GP exits the company16. Hence, Private Equity firms employ leveraged buyout to gain additional alpha on top of the nominal growth that is achieved through other operational tactics. Operating the target company is more important nowadays that ever before. Previously, private equity firms used financial engineering as their sole selling point but as the number of firms has grown in size it is fair to say that financial engineering isn’t the only way to differentiate from the pack. As a result, efficient operators have proven to be more successful in the industry and LPs are taking notice of this. A few key tactics that help private equity firms operate their portfolio companies better is right-sizing a firm17. For example, a lot of businesses sometimes overhire for tasks that may not need another employee. This overhire increases labor costs and hurts the bottom line. By right-sizing a portfolio company, the private equity firm can improve the bottom line just in a matter of days. Additionally, most companies that are brought up by private equity firms are family owned businesses that may not have expertise in implementing better technology to improve the operational efficiency of the company. Private Equity firms can help these portfolio companies implement better technology to streamline operations which in turn increases operational efficiency. The additional increase in operational efficiency may even allow the portfolio company to focus more on growth which in turn can increase the top line revenue. Now that we have seen some of the benefits of properly implementing good operating practices, it is also important to consider that sometimes it may lead to more harm than good. Right-sizing a portfolio company when they might be under-sized hurts the top line revenue more than expected. Additionally, it also brings fear to the employees of the portfolio company which may lead to bad company morale. A recent famous example is the story of Red Lobster that was previously owned by a private equity firm18. Red Lobster is a famous restaurant chain that focuses on seafood related cuisines. It has a long history and has been ingrained in Post-war American culture. Fast forward to 2014, it was acquired by a private equity firm, Golden Gate Capital for $2.1 billion. It was previously owned by Darden Foods which is a firm that specialised in chain based restaurants. However, Red Lobster ultimate downfall started when Golden Gate Capital took over. Instantly, Golden Gate sold Red Lobster’s real estate holdings to a separate company owned by Golden Gate Capital to finance the deal. Red Lobster had to now lease the restaurant space at higher than market value leases. Golden Gate Capital sold off their stake in the business completely by 2020. This quick profiteering started a downward trend that led to it’s ultimate demise in 2024. In the eyes of their LPs, they actually made superior returns but the damage to their reputation is something they didn’t consider in their investing and operating philosophy. There are countless examples of good companies that have been put to their death bed by private equity but on the other hand there are also examples of bad companies that have been restructured to become icons in their field. Hence, it is important to highlight the role of investing and operating as a key factor when it comes to private equity. It is a process that has implications to current, former and future stakeholders. It is also important for private equity firms to understand that their actions have serious implications to their reputation and the industry as whole, which is why private equity firms have been increasingly focusing their efforts on operational efficiencies that make sure that current and future stakeholders are kept in mind in this process19.

Exits and Returns

The final step in a fund life cycle is understanding the best exit strategy as well as making sure return expectations are met. As we noticed, there can be a number of issues that can disrupt the fund life cycle process. This is why private equity firms try to strategise an exit strategy before they even invest in a firm. Usually, a private equity firm can has this exit strategy mapped out in their initial investment thesis because considering the worst possible outcome is very important as it can affect an entire fund’s return profile20. A private equity fund has a finite fund life of 6 - 8 years which creates considerable pressure to choose the best exit strategy to achieve those high returns warranted by their LPs. There are a few key options that are available to private equity firms to exit their portfolio company. Some of them are as follows21: • Initial Public Offering(IPO) - This is the most preferred method as it has a possibility of generating the highest return on capital employed. It also gives the private equity firm an option to return capital to their LPs in the form of public shares of the company which can be sold as market value. LPs either can hold on to these shares or sell them as soon as they receive it. It has gained significant popularity as some companies which were previously owned by private equity firms have gained public notoriety as out performers in their space. Previously, private equity firms just sold the public equity at market value on the day of the IPO to lock in their gains. • Secondary Sales - This method involves closed door negotiations between the GP and a buyer22. The buyer can be a publicly listed company or another private equity firm. Secondary sales are a grey area as it depends on the negotiating power that a private equity firm has along with the quality of the portfolio company. Understanding who is the buyer usually tells a lot about this exit as it greatly helps to understand why the portfolio company is being sold in such a manner. For example, a public company that has a Software-as-a-service business may find value in putting the portfolio company’s product in their ecosystem. Whereas another private equity firm as a buyer may want to buy the portfolio company for their new fund might demand a lower price as compared to the public company. As such, secondary sales have a grey area until a deal is finalised and intentions are made clear. Secondary sales help the private equity ecosystem running if the IPO markets are not favourable due to economic downturns. As of this paper, we are currently in an economic downturn which is why private equity firms have been resolving to newer ways to exit out of a portfolio company. • Continuation Funds - The crux of this paper is dive deeper into continuation funds and the ethical implications behind it. However, as mentioned previously, we are in an economic downturn and continuation funds have seen their growing popularity due to the lack of a strong IPO market or a strong secondary market. A continuation fund as the name implies is a fund that is solely focused on continuing the private equity firm’s investment in a specific portfolio company. They usually typically are set to last up to six years23. To achieve this, private equity firms put more of their capital in the portfolio company to buy out LPs who do not want to continue further. Additionally, it also serves as a great tool to keep high performing assets under GP ownership. There are a number of reasons for private equity firms to use continuation funds which we will discuss later on in the paper. As we have seen the 3 major ways private equity firms exit out of their portfolio companies, now we need to focus on the returns aspect of the fund life cycle. Returns play a very important role in the private equity space as most portfolio companies aren’t valued on regular basis like public companies are. Hence, it plays a vital role in understanding the fund returns as they serve as a barometer for the private equity space. It helps the ecosystem down to the venture capital side of private equity. Additionally, it also serves a key function in the fundraising process for the next fund for the private equity firm. Returns of a private equity firm are calculated in a few ways. Below are a few key metrics used by the industry24: • Internal Rate of Return (IRR) • Modified IRR (MIRR) • Return on Capital Employed • Return on Invested Capital • Total Value to Paid-in • Distributions to Paid-in • Residual Value to Paid-in There are a number of ways for private equity firms to represent their fund performance. However, there are underlying assumptions to each performance metric that brings to question the actual performance of the private equity fund. For example, the Internal Rate of Return (IRR) is the performance metric of choice in the Private Equity industry. It represents the discount rate at which the net present value (NPV) of a series of investments is zero. However, the assumptions underlying the IRR have created contention. The built-in “reinvestment assumption” that capital distributed to LPs early on will be reinvested over the life of the fund at the same IRR as generated at initial exit. As such a high IRR (>25%) generated by a successful exit early in a private equity fund’s life is likely to overstate actual economic performance. The mechanics of the IRR calculation thus provide an incentive for GPs to aggressively exit portfolio companies earlier in a fund’s lifecycle to “lock in” a high IRR25. As a result, there are mulitple studies that look into performance calculations conducted by private equity firms to gauge the health of the industry and to gain a better understanding of the industry’s explosive growth over the recent years. These performance metrics also trickle down into the venture capital space as well as private credit. Keeping this in mind it is easy to see why return calculations matter in the fund life cycle. To wrap up the fund lifecycle, the entire process from fundraising to returns involves a lot of careful decision-making along with a good understanding of financial engineering. It also serves to show why private equity has gain public notoriety in it’s short span in the capital markets. No matter which lens you see private equity, the fact of the matter is that the industry is here to stay and will keep growing at as time progresses, which is why it is important to understand the crux of this paper.

Why Continuation Funds Matter?

As mentioned previously, Continuation funds have proven to be an effective way for private equity funds to exit out of their investment in a portfolio company. Bain & Company, a global consulting firm conducts a yearly study on the Private equity industry which is published every year in March26. Recently in 2024, the study looked at the 2023 outlook of the private equity industry in which they noted that global buyout deal value fell below 2015 value. More suprisingly was the global buyout-backed exit value which fell below 2015 value as well. However, fundraising just dipped 1% below 2021 value. This divergance brings to question why exactly would LPs be interested in private equity when the report points out the record-high number of aging unexited companies in buyout portfolios has stanched the flow of capital back to LPs. As of 2023 the global buyout unrealized value is sitting at 28 Trillion. Additionally, the median holding period for buyout-backed exits has been growing Y-O-Y with 2023 sitting at 6.1 years. Hence, it is imperitive for Private equity firms to inovate their exit strategy and continuation funds have proven to be great solution so far. We will look at continuation funds from 3 angles, the Opimistic view, the Contrarain view and the Equivocal view. This analysis would help us understand the views of the private equity industry as well as the views of the LPs. Additionally, it will help us explore the ethics behind continuation funds and regulations as such.

The Opimistic View

Continuation Funds are a great tool for private equity funds to exit out of their portfolio companies. It allows the fund to close down and return capital to their LPs. The contruction of a continuation funds work is important to understand how capital is returned. A private equity fund can initiate a continuation fund by asking it’s current LPs if they would like to be a part of the continuation fund. In these conversations, LPs can understand their reasoning behind putting a portfolio company in a continuation fund. If a portfolio company has additional value that can be unlocked at a later period, it would be wise to stay on board till the company has reached it’s full potential27. It also provides additional distributions if possible to those current LPs. However, if a current investor decides they don’t want to be part of the continuation fund, they will be have their capital returned to them. The private equity firm will also try to gain additional LPs to be a part of the continuation fund to fill out the equity gap. It allows newer LPs to be part of the growth story of the target portfolio company. Additionally, the private equity firm may put more capital from their side to lower equity and debt gaps. The private equity firm does this to show conviction on their side that the portfolio comany is a worthwhile investment. Continuation Funds also offer another advantage: the opportunity for capital infusion to support their expansion when most of the capital is withdrawn to pay down debt28. Proponents of Continuation Funds will argue that the benefits of such funds outweight the concerns as possed by others. Thus, this is seen as a “win-win-win” for all parties involved.

The Contrarain View

Continuation Funds have their downfalls which may seem obvious to most as such many LPs aren’t fans of them. Empirical analysis has shown that around 80-90% of the initial LPs choose to withdraw their capital and not participate in continuation funds29. It also raises the question about ethical conflicts as previous LPs would like to recieve a high exit value for the portfolio company and new LPs would like to pay a lower amount for the portfolio company. For example, in 2022, over 90% of continuation fund transactions were traded at some level of discount30. This negotiation is usually done by the GP so it puts them in a position where they are committed to two groups of LPs on the table whose interests are in direct conflict with each other31. GPs being a fiduciary to both the legacy fund and the continuation fund must act in the best interest of each group and maneuver with a web of complex and conflicting loyalties32. These conflicts are further enhanced by their significant involvment in the negotiation, valuation and pricing process. Additionally, the industry is a black box for information so LPs cannot make wise decisions on their part, thus relying solely on the private equity firm to provide them enough information that will allow them to make the right decision. It is also important to note that most LPs aren’t able to capture the attention of the GP as they are inudated with other responsibilities related to other funds they manage. Even if an investor is able to garner their attention, most are afraid to raise their concerns related to the private equity firm’s ethical dealing out of the fear of being excluded from future funds. Another aspect of the contrarain view is related to what portfolio companies are put inside these continuation funds. If it is known that a portfolio company is underperforming and the GP believe there is untapped future growth, how is one to assess this growth potential. During the life of the fund, the portfolio company has been underperforming so it comes as a shock to LPs when GPs believe there is untapped growth. However in this web of conflicts, one thing is certain that the GP almost always wins. It provides the GP an additional source of income as management fees are charged to the continuation fund as well along with the carried interest they earn by making sure they are able to keep the portfolio company under their control33. Additionally, GPs could also use a continuation fund to meet a specific carry hurdle rate and therefore collect the 20% carried interest once the continuation fund realizes the returns on that specific asset.

The Equivocal View

One aspect of Continuation funds is it’s ability to return capital to LPs. Regardless of how the terms are drawn up, it’s opened an avenue for open discussions regarding portfolio companies. As mentioned previously, most LPs look to get out of private equity funds as the fund nears the end. Continuation funds provide an great mechanism for LPs to recieve their capital back albeit with the possibility of unfavourable terms. It also allows LPs who see the portfolio company with potential to roll over their interests to the continuation fund. This allows private equity firms to maintain control of trophy assets for a high exit valuation at the end of the continuation fund. It also serves as a good exit strategy when IPO markets are depressed as we have seen in recent years. Additionally, it helps cyclical portfolio companies that may not see high exit value in depressed periods to fly under the public radar till the time when the economic cycle is more favourable to such companies. This gives additional flexibility to portfolio companies to not worry about the IPO process which can be extremely through. However it does shine light on the private equity firm’s investment process which can be called to scrutiny in future funds. This may lead to future LPs to be cautious about provide more capital to such firms in the future. The possibility of bad investment decisions is not an uncommon aspect in the industry. For example, the story of RJR Nabisco which was acquired by KKR for $25 billion was the largest leveraged buyout at the time. However, it saddled a reasonably healthy company with an unstainable level of debt. Hence, it is always wise to assume the worst as we have shown with the investment process. Continuation funds “used to be an ‘Island of Misfit Toys’ for underperforming assets, but now they can contain prized private opportunities”, noted Nicolas Brown, a managing partner with Granite Harbor Advisors34. To top it off, Continuation funds also help raise additional capital that might not be available to them in their intital funds as we noted previously. This additional capital can help with further growth expansion or bolstering their capital structure if things went wrong during the operating phase. Now that we have seen viewpoints from each angle, it is wise to assume that there might not be a simple answer to this complex web of problems. However, in the next section we will discuss possible solutions that may benefit the industry.

Solutions for Continuation Funds

Even though Continuation Funds have their place in the exit strategy, it is wise to assume that there might be a few key aspects that may help reform the strategy that would be beneficial for both the GPs and the LPs. In this section we will discuss possible solutions that may exist in our current framework as well as solutions that would need additional legislation and regulation. Below is a breakdown of solutions we propose after our research.

1. Additional Disclosures
2. Independent Advisory firms
3. Conflict analysis
4. Regulations and Legislation

Additional Disclosures

As the title suggests, having disclosures that properly note all the possible conflicts that may exist provides LPs a chance to understand the underlying dynamics at play. Lead LPs are often repeat players, including other private equity funds that specialised in secondary transactions. Usually priority is given to such lead LPs due to their nature of business. Hence, noting such the private equity firm’s interactions with lead LPs in the disclosures gives LPs a chance to understand the dynamics of the continuation fund. It also provides a glimpse of the negotiations that occur behind the curtain as well. Additionally, GPs exercise substantial control over the information flow about the portfolio company’s performance. This asymmetry of information can be avoided by provided neccessary information needed by LPs to make their decision if they wish to roll their interest over to the continuation fund. Disclosures are a powerful tool that help LPs and private equity firms as well. It serves as a tool of mutual understanding that both parties are sophisticated investors in their regard and are able to qualily their decision-making. It also empowers the LPs to have better relations with GP and provide them meaningful viewpoints that can assist them in future transactions as well as shine light on the current continuation fund process as well.

Independent Advisory Firms

Even though, additional disclosures may provide helpful information to LPs they are only useful if the investor is able to discern the porfolio company as an industry professional. As we noted earlier, most LPs are accredited investors who have gained significant wealth through their personal careers and have invested in private equity to grow their wealth over time. As a result, they might not have the right expertise to make informed decisions even with additional disclosures. Hence, Independent Advisory firms would be a possible solution to help fill the knowledge gap. They can be employed by the investor for a small fee to understand the implications of the continuation fund and the assets that would be placed in them. Such a service would be quite beneficial as continuation funds gain more traction in the industry. Understandable it may be time consuming for the investor to seek an advisory firm that can delve into the complexity of every continuation fund. However, GPs can employ such independent advisory firm on the behalf of LPs to conduct a through analysis of the exit value of the portfolio company in the current market conditions as presented. Understandably this would create a conflict between the advisory firm and the private equity firm as they would prefer a favourable opinion in lieu of payment for such services. Hence, it is wise to take such an opinion with a grain of salt. Audit firms provide a similar service however their opinion only speaks to the accuracy of accounting practices employed and not the facts stated behind the numbers. Independent Advisory firms would be a beneficial start to properly standardise an portion of the private equity industry that is sure to ballon as time goes on.

Conflict Analysis

Another method to alleivate investor concerns would be to provide a Conflict Analysis. This analysis would provide information about the private equity firm, the lead LPs, the portfolio company and a market analysis of current valuation. Such an analysis would provide better understanding of the deal dynamics at play. It would also open the floor to debate between the LPs and the private equity firm to potential oversight on their part. In turn, such transparency would be rewarded quite favourable as the private equity firm is not shy to disclose their exit strategy. It also puts the LPs in high regard of private equity firm because they are able to be transparent with their LPs. LPs might not roll over their investments from the old fund to the new fund but they will definetely apreciate the value of it and would definetely sign up for future funds. It also invites the private equity firm to have honest conversations with their lead LPs as it shines more light into the inner investor circle and bring out the neccessary conversations that would allow them to negotiate better terms for previous fund LPs and new fund LPs35. Understandable, this would also mean that any side contracts might come out into the open but it provides valuable information to all LPs involved.

Regulations and Legislation

Regulations are looked unfavourable in the private equity industry for a number of reasons. They are costly to enforce and abid by which give them a very unfavourable outlook in the finance world. However, regulations most often look out for those participants without a voice in the industry. Hence, it is most definetely an interesting solution that may need to be considered. After all, Strong capital markets are made stronger with regulations and proper enforcement. Unfortunately, it would be a mamouth undertaking for an regulatory body to take on especially when considering the private equity industry has limited investor protection and has the highest risk level posible for LPs. This is why only institutional and accredited LPs are allowed to invest in private equity. The regulations that surround private equity are considered out of reach for the general public which is why there were lax regulations internally. However, research has shown that increased regulations does in fact increase investor confidence and provides LPs proper knowledge to be on the same level playing field as many lead LPs and institutional investors. Currently, US is the largest private equity market in the world and is only expected to grow larger. As a result, the Securities and Exchange Commission (SEC) has introduced a number of sweeping rulings regarding regulations in the private asset space. A recent ruling by the SEC on November 13, 2023 extended the scope of SEC regulations and enforcement to cover continuation funds and secondary activities36. The 656 page ruling covered a variety of issues in the private asset space and extended increased protection to LPs on every level. Certainly other countries will follow suit as well but this is a great start to extending proper regulations to an industry that hasn’t seen much regulatory activity for a while. Legislation usually follows suit but it would be a while before proper enforcement related legislation could be introduced. We have covered a few key solutions that would help the LPs and the private equity industry in their forward march towards continuation funds. There are other niche ideas that have been proposed in academia but that haven’t been tested pratically, hence it is hard to discern if they hold merit for discussions as of yet. But this is what makes private equity special, their ability to move quickly and test novel ideas on the bleeding edge of financial engineering is what pushes the bounds of what is possible. Private equity industry is a niche sector that tends to inovate and evolve in such a manner that these techniques get used in other areas of the private & public markets.

Conclusion

Mitt Romney, the Co-founder of Bain Capital once said " Private Equity can bring capital, expertise and a long-term perspective to companies, helping them to thrive and grow in ways they might not otherwise be able to.“37. This prespective really gives light to why private equity is here to stay and why continuation funds which may seem has a house takes all scenario might otherwise be a commonplace transaction in the near future. Hence, LPs need to adapt to the changing environments and work with their respective private equity firms to achieve greater cohesion. Additionally, we may also soon see continuation funds trickle down into other areas of the private asset space which is why it is important to start having discussions about continuation funds as they stand. There is no reason for the continuation funds trend to end anytime soon and infact we might see a new sector in the not so distant future where firms that focuses solely on continuation fund transactions become staples in the industry. In conclusion, we believe there are many ways for GPs to achieve a better understanding with their LPs which in turn will provide continuation funds a better chance for success and their continued growth.

Personal Analysis

This indepth analysis would help me extend my knowledge further in the field of Private Equity, and serve as a benchmark for future employers to see my depth of knowledge in the field. During this process, I was able to interact with multiple professionals and lawyers to gain an deep insight in a world that is often cloaked in mystery. Additionally, it helped strengthen my relationships I have formed at major Private Equity firms as a formidable professional with deep expertise in due dilligence and exit strategics, serving as a soundboard for future ideas that may come down the pipeline as the industry looks to evolve from traditional techniques that were once held as a gold standard. Personally, this exercise also helped me understand the politics that occur in boardrooms across the world and how to solve issues that may not have a directly identifiable path to success. I have just scratched the surface in the paper and I do see myself delving more into this world as I progress professionally.

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