Non-public Fairness’s New Exit Playbook

Non-public fairness (PE) exit methods have tailored and developed previous the times of clean IPO runways and fast M&A turnarounds to incorporate continuation funds. The backdrop of low financing prices that inspired file transaction volumes, speedy fund rotations, and regular exit alternatives have evaporated during the last 5 years. In at present’s high-rate surroundings, exit choices have narrowed, financing has develop into dearer, and holding durations have lengthened. Final yr, common buyout holding durations rose to six.7 years from a two-decade common of 5.7 years with the exit backlog now greater than at any level since 2005, in response to 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 personal fairness relatively 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 current, maturing fund into a brand new car, typically managed by the identical normal associate (GP). Present 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 durations.

The marketplace for continuation funds has expanded rapidly. In 2024, 96 such autos had 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 might 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, world M&A recorded its lowest degree in a decadeunderscoring the post-pandemic slowdown in dealmaking. International PE exit depend declined to three,796 from the 2021 peak of 4,383. Whereas off its highs, world PE dry powder continues to be round $2.5 trillion as of mid-2025, and the strain to deploy capital stays excessive whilst exit channels tighten. A number of forces underpin the current proliferation. Amongst them: a scarcity of conventional exit paths, a looming maturity wall, and a necessity for LPs to liberate money.

First, rising financing prices have constrained leveraged buyouts and widened the bid-ask hole in M&A offers. Continuation funds enable 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 are actually six years or older, with 1,607 funds set to wind down in 2025 or 2026. Continuation funds enable corporations to increase worth creation with out compelled gross sales.

Lastly, these funds align with investor demand for flexibility. LPs can exit for fast liquidity or roll over to chase future upside. New buyers achieve publicity to confirmed property with decrease blind-pool threat. 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, current 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. Latest 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, reminiscent of Lime Rock Companions’ use of continuation buildings in vitality property, illustrate how managers can lengthen worth creation by 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 an excellent 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 buildings 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 honest market worth. Many corporations tackle this by partaking third-party monetary advisors for unbiased opinions or conducting auctions to make sure market-driven valuations. But, LPs typically lack the assets to completely vet these offers, and the concentrated threat of single-asset funds (vs. diversified secondary funds) can deter rollovers.

Compounding these considerations, the 2024 Fifth Circuit Court docket of Appeals choice 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 additionally permits for quicker transaction execution. It additionally will increase the onus on buyers to carry out thorough due diligence underscoring the necessity for voluntary and strong governance.

Finest Practices for Buyers

For these navigating continuation funds, a number of finest practices can mitigate dangers and improve outcomes:

1. Guarantee Impartial Valuation: : Demand third-party valuations from respected advisors, reminiscent of Houlihan Lokey or Evercoreto confirm honest asset pricing and search public sale processes the place possible. LPs ought to request detailed pricing methodologies and comparable transaction knowledge.
2. Align GP and LP Incentives: Require GPs to roll over 100% of their funding and negotiate carried curiosity and management-fee buildings that stability long-term alignment with investor safety.
3. Assess Focus Threat: 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 assessments below adversarial market situations.
4. 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.
5. Leverage Specialist Experience: Interact advisors skilled in secondary and GP-led transactions to evaluate valuation methodologies, cash-flow fashions, and regulatory implications.
6. Monitor Submit-Transaction Efficiency: Require clear, periodic reporting on operational and monetary metrics to verify that prolonged holding durations generate incremental worth.
7. Interact 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 honest outcomes.

The New, New PE Regular

For buyers, success on this surroundings 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 enlargement and the present high-rate adjustment is obvious: in personal markets, worth creation endures solely when alignment, transparency, and self-discipline do.