Personal Fairness’s New Exit Playbook

Personal fairness (PE) exit methods have tailored and developed previous the times of easy IPO runways and fast M&A turnarounds to incorporate continuation funds. The backdrop of low financing prices that inspired file transaction volumes, fast fund rotations, and regular exit alternatives have evaporated during the last 5 years. In in the present day’s high-rate surroundings, exit choices have narrowed, financing has develop into costlier, and holding durations have lengthened. Final 12 months, common buyout holding durations rose to six.7 years from a two-decade common of 5.7 years with the exit backlog now larger than at any level since 2005, in keeping with McKinsey analysis.

Enter the continuation fund, which has quickly moved from area of interest to mainstream, providing alternative to many traders whereas inviting warning from others. The emergence of continuation funds displays a structural evolution in non-public fairness reasonably than a short lived 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 automobile, typically managed by the identical basic accomplice (GP). Present restricted companions (LPs) can both money out or roll them into the brand new construction, whereas new traders 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, international M&A recorded its lowest degree in a decade, underscoring the post-pandemic slowdown in dealmaking. World PE exit rely declined to three,796 from the 2021 peak of 4,383. Whereas off its highs, international PE dry powder continues to be round $2.5 trillion as of mid-2025, and the strain to deploy capital stays excessive at the same time as 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 release money.

First, rising financing prices have constrained leveraged buyouts and widened the bid-ask hole in M&A offers. Continuation funds permit managers to retain high-conviction property and supply traders with liquidity choices. The upcoming 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 permit corporations to increase worth creation with out compelled gross sales.

Lastly, these funds align with investor demand for flexibility. LPs can exit for rapid liquidity or roll over to chase future upside. New traders acquire publicity to confirmed property with decrease blind-pool danger. 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 traders. For GPs, this extension permits them to proceed managing high-performing property, thereby producing continued administration charges and carried curiosity.

LPs acquire liquidity with out sacrificing potential upside, whereas new traders entry mature property with a clearer path to returns. Current 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 attraction. Morgan Stanley discovered that upper-quartile continuation funds achieved 1.8x MOIC, in contrast with 1.6x for comparable buyout funds. Sector-specific examples, corresponding to Lime Rock Companions’ use of continuation constructions in vitality property, illustrate how managers can prolong worth creation by way of 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 an ideal 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. Traders have raised eyebrows on the nature of those transactions, with critics likening them to round financing constructions if not fastidiously ruled. For a deeper understanding of this dynamic, learn CFA Institute Analysis and Coverage Middle’s report Continuation Funds: Ethics in Personal Markets.

Transparency in valuation can also be important. LPs should belief that the acquisition worth for transferred property displays truthful market worth. Many corporations tackle this by participating third-party monetary advisors for unbiased opinions or conducting auctions to make sure market-driven valuations. But, LPs typically lack the sources to completely vet these offers, and the concentrated danger of single-asset funds (vs. diversified secondary funds) can deter rollovers.

Compounding these considerations, the 2024 Fifth Circuit Court docket of Appeals resolution to vacate parts of the SEC’s Personal Fund Advisers Rule eliminated necessary fairness-opinion and disclosure necessities for continuation funds. This ruling reduces necessary reporting necessities, probably rising battle dangers as GPs face much less regulatory oversight but in addition permits for quicker transaction execution. It additionally will increase the onus on traders to carry out thorough due diligence underscoring the necessity for voluntary and strong governance.

Greatest Practices for Traders

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

1. Guarantee Impartial Valuation: : Demand third-party valuations from respected advisors, corresponding to Houlihan Lokey or Evercore, to confirm truthful 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 constructions that steadiness long-term alignment with investor safety.
3. Assess Focus Danger: Single-asset continuation funds can introduce heightened publicity; traders ought to examine their risk-return profiles in opposition to diversified secondary funds and conduct stress exams beneath hostile 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: Have interaction advisors skilled in secondary and GP-led transactions to evaluate valuation methodologies, cash-flow fashions, and regulatory implications.
6. Monitor Put up-Transaction Efficiency: Require clear, periodic reporting on operational and monetary metrics to verify that prolonged holding durations generate incremental worth.
7. Have interaction in Energetic Dialogue: Foster open communication with GPs to handle considerations about conflicts or transparency. Take part in LP advisory committees to affect governance and guarantee accountability. Energetic engagement can deter self-dealing and promote truthful outcomes.

The New, New PE Regular

For traders, success on this surroundings relies upon much less on the structural novelty of the automobile and extra on the rigor of its oversight. The lesson from each the zero-rate growth and the present high-rate adjustment is obvious: in non-public markets, worth creation endures solely when alignment, transparency, and self-discipline do.