I remember when funds set up to allow managers to continue managing assets were once referred to as ‘zombie fund transactions’ or ‘fund restructurings’. At some point around 2018, the language changed to the much more positive-sounding ‘continuation funds’ and ‘continuation vehicles’.

Whether there was a strategic communications firm pushing a change in lexicon in the market, we may never know.

Today, so-called continuation funds are a staple of private markets. They were even selected as the preferred method of exit – above dual-track processes, IPOs and private auctions – in an October study of mid-market private equity fund managers by Deutsche Numis.

“Fundamentally, there’s a flaw in the private equity infrastructure,” Jeff Hammer, global co-head of secondaries at Manulife Investment Management, told me during an episode of PEI’s Spotlight podcast in November. “Partnerships, by their nature, do not create liquidity. Yet, most people agree that liquidity should not be a punitive afterthought – it needs to be a right. And [continuation vehicles] really have enshrined that right.”

Continuation fund use has been growing over the years. Such vehicles accounted for around 80 percent, or $14.4 billion, of total sponsor-initiated secondaries market deal volume in the first half of this year – the same on a percentage basis as the first half of 2022, according to data from Jefferies. In the first half of 2019, as a comparison, continuation funds accounted for just 41 percent of sponsor-led volume.

At Secondaries Investor, we observed the continuation fund market breaking new ground in 2023. Japan saw the creation of its first such fund, with Tokyo-based buyout firm J-STAR completing a multi-asset GP-led involving four waste treatment and recycling assets in a Neuberger Berman-backed deal. Transactions became more complex and started to involve concurrent M&A processes, such as financial services investor Pollen Street Capital‘s continuation fund on insurance group Markerstudy and debt software company Aryza, in which the former was subject to a concurrent add-on acquisition process.

Continuation funds even spread to the impact investing market this year, with Stockholm-headquartered Summa Equity closing a €550 million single-asset continuation fund for waste management company NG Group in December.

One exciting trend that emerged this year has been the availability of returns data from continuation funds themselves. Investors in TPG‘s continuation fund for Creative Artists Agency, for example, are understood to be making a return of around 2x MOIC on the company’s exit to Artémis, the family office of French billionaire François-Henri Pinault, we reported in November. This will be accompanied by an IRR of more than 30 percent.

Healthcare specialist ArchiMed‘s exit of Polyplus, a developer of technology used in gene and cell therapy, netted investors in its €242 million continuation fund PolyMED a return of between 4.5 and 5x, Denis Ribon, chairman and managing partner of ArchiMed, told Secondaries Investor in April.

Continuation funds are also delivering returns for those LPs that have chosen not to partake in them and instead sell their exposure. In December, UK financial services and software-focused investor AnaCap said the continuation fund it ran this year involving two assets had contributed to generating a 3.5x money multiple and a 52 percent IRR for its 2016 AnaCap Financial Partners III.

“Investors that have invested into these deals [continuation funds] do have a fair amount of information in their own portfolios about how those deals have done, and they wouldn’t keep investing in them if they weren’t generating appropriate returns. And they keep investing in them,” Holcombe Green, global head of private capital advisory at Lazard, told me this week.

“The anecdotal [data] and what there is in aggregated data suggests to me that investors are getting a private equity-like return out of continuation funds.”

Looking to the future, it’s clear that certain issues will need to be ironed out if the continuation fund market hopes to continue its growth. At an industry event held by a leading law firm in October, two GPs that had run continuation funds pointed to the potential mismatch in desires surrounding how quickly to close a transaction as “a real consideration when you think about other options out there”. While an M&A process can be negotiated in a week, a continuation fund may take three weeks to negotiate with lead secondaries buyers, which can be “very frustrating”, according to one of the GPs.

Several best practices have been identified in recent years for interacting with a fund’s LP base in these transactions. As more managers contemplate such processes, it will become vital to effectively address potential conflict points between the GP and secondaries buyers.

Write to the author: adam.l@pei.group

This will be the last Friday Letter for 2023. We hope you have a restful break and look forward to seeing you in early January.