The Growing Prominence of Continuation Vehicles

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• On: 05/03/2023 13:00:11
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This is an excerpt from NCPERS Spring 2023 issue of PERSist, originally published March 21, 2023.

In the last 24 months, the market has seen an increase in the number of continuation funds, which allow GPs to roll an asset (or assets) from an existing fund or multiple funds into a new investment vehicle with fresh or re-start capital, rather than selling the asset to an outside buyer. Historically, these vehicles served as a way to give these companies more time to deliver on expected returns. More recently, however, GPs are recapitalizing their higher-performing investments—the so-called “crown jewels” of their portfolios—as a way to maintain exposure while providing additional capital for growth initiatives.
 
While there are certainly risks involved in these deals, namely around potential conflicts of interest and GP alignment, there can be benefits as well. GPs have the ability to continue managing a high-performing asset, and this comes with the benefit of a larger fee base and the resetting of the deal carry pool, which can re-incentivize the team for continued value creation. For LPs, assuming that the asset has been fairly priced and that the GP's motivations are properly aligned, these vehicles can provide an attractive opportunity to maintain exposure to a successful company at a lower fee/carry basis. In addition, some LPs have the ability to invest secondary capital into what may be perceived as a less risky opportunity (when compared to buying a new unknown asset).  Over time, there is the potential for LPs to realize strong risk-adjusted returns, particularly with GPs and management teams that have worked together successfully in the past.
 
Many LPs are currently not set up to participate in continuation vehicles, while others choose not to participate given structural constraints or the need for liquidity. Arguably, continuation vehicle transactions can force traditional fund LPs to be more involved co-investors, requiring them to undertake additional underwriting and monitoring processes. These dynamics ultimately cause most LPs to sell their positions instead of rolling their exposure into attractive continuation vehicle opportunities.
 
The decision to participate in a continuation vehicle involves a complex set of issues that are critical for an LP to understand. High-quality GPs typically have a strong value creation plan outlined on a particular asset or set of assets and will often commit a considerable amount of time and capital to each deal. A reasonable proxy to measure GP alignment is the amount of carried interest that the GP has created via the platform exit and any subsequent portion they may roll into the new vehicle. Additionally, it is critical for LPs to understand the business motivations and alignment of other LPs/LPAC members who may have to provide approvals to waive conflicts or approve the actions of the GP. There may be questions, for instance, around whether a given asset manager—with both primary and secondary businesses—would be more likely to approve a deal that benefits its secondary arm, even if that deal is potentially less advantageous for its primary fund investors that may not be in a position to participate due to structural and/or timing limitations.
 
With appropriate alignment, transparency, and governance in place, continuation vehicles can be an attractive investment option for LPs.

About the author:
Mina Pacheco Nazemi is the Head of the Diversified Alternative Equity team and serves on both the investment committee and valuation committee. She is also responsible for originating, underwriting and monitoring primary fund, direct/co-investments, and secondary fund opportunities for private equity and real assets. Mina has worked in the industry since 1998 with experience as a General Partner and Limited Partner investor in private markets and focused on underwriting direct/co-investment opportunities. Prior to joining the firm in 2017, Mina held several leadership and investment positions including Co-Founder and Partner at Aldea Capital Partners and Partner and Investment Committee Member at GCM Grosvenor Customized Fund Investment Group (formerly Credit Suisse CFIG). She is an alumna of Sponsors for Education Opportunity (SEO) and Robert Toigo Foundation. She also is a board member of the Pan American Development Fund and serves on the investment committee for the City of Hope.  Additionally, Mina is a current Finance Fellow for The Aspen Institute.  Mina holds a Bachelor of Arts with honors in Economics and Political Science from Stanford University and her Master of Business Administration from Harvard Business School.