Continuation Funds Bring New Opportunities and New Complexity

Authored by: Merryn Rosewall, Principal, Risk & Quality Control
Updated on: May 21, 2025

Originally published in Private Funds CFO

Over the last few years, we’ve observed a noticeable uptick in continuation funds launched by the private equity sponsors we serve. While the absolute number may appear modest, the momentum reflects a significant shift, as continuation funds have taken on a more prominent and strategic role in the market.

Historically, a continuation fund acquired near end-of-life investments held by an affiliated legacy fund. This was generally because the assets were underperforming and the GP required additional time to turn them around for a sale, even if the outcome was to limit the ultimate loss.

Recently, however, the reputation of continuation funds has turned around completely as they have become a strategic tool to optimize the return on highly promising assets. It is also becoming increasingly common to see continuation funds employed earlier in the investment lifecycle to extend the period of ownership of these standout portfolio companies to maximize value.

In addition, continuation funds are much more likely today to be used to attract new investors, including an increasing number of secondaries-focused funds, or additional funds from existing investors who want to fuel ongoing growth and reap the rewards. At the same time, they present an opportunity for some investors to sell their interest to obtain liquidity.

 Because of the evolution in how firms are using continuation funds and increasing demand for secondary transactions, they are being launched much more frequently, and LPs are paying attention to these vehicles with the prospect of generating strong multiples. While beneficial for investors and firms alike, continuation funds create new challenges for fund administration and their newfound popularity means more firms will have to address the associated risks.

Investor classes

Unlike a traditional fund transaction where almost all investors have the same terms, continuation funds may have multiple investor classes: selling investors who are divesting their stake in the asset, rollover investors who were invested in the original fund and new investors.

New investors and rollover investors may be subject to different terms and economics, which impact their returns and fees. Different terms addressing management fees, carried interest, waterfall structures and preferred returns underscore the need for careful negotiation and structuring to ensure alignment between investor classes.

Typically, the costs associated with the transaction, including formation fees for the new fund entities, are specifically allocated between investor classes, as stipulated within the legal agreements. It is essential to clearly define the allocation methodology upfront to ensure fairness and transparency among all stakeholders.

New investors may bear a proportionate share of the transaction costs based on their commitment size or the fair market value of their acquired interest. Rollover investors may see their costs allocated based on their continued participation in the fund, potentially including a share of legal, administrative and structuring expenses.

Carried interest

Carried interest is another area of complexity with continuation funds.

If carried interest on rollover investors is not crystallized in the legacy fund at the time of the transaction, LP agreement provisions typically incorporate contributions and distributions across the legacy and continuation/rollover fund, maintaining the original economics. It is crucial to establish a clear framework for how carried interest is calculated, allocated and distributed between the legacy and continuation funds to ensure transparency among investors.

Alternatively, the carried interest model may reset, with rates that step up with increasing investment return based on invested or contributed capital, including the fair value of investments contributed. For rollover investors, the reset should not disadvantage them compared to their original terms, and any changes in hurdle rates, preferred returns or waterfall structures should be explicitly outlined. It’s important for new investors to understand how the stepped-up carry structure aligns with their expected returns.

One size doesn’t fit all

Different continuation funds will have different governing provisions, so the back office can’t just follow the same playbook each time a new continuation fund is created.

For example, continuation funds are created to hold the investment and the related equity interests of the new investors. However, rollover investors may participate in the continuation fund, a newly established rollover vehicle or remain in the legacy fund.

Accounting considerations include recognizing non-cash (in-kind) distributions and contributions between the legacy fund, the selling and rollover investors and the continuation and rollover funds. Given these complexities, expert fund administration and technology-driven solutions are essential to maintaining transparency, accuracy and investor confidence throughout the continuation fund lifecycle.

Fund administrators must take a customized approach to managing each continuation fund’s unique structure, ensuring accurate accounting and reporting, seamless technology integration and clear communication with stakeholders. A flexible, expertise-driven approach is integral to ensuring smooth administration, compliance and investor confidence.

Complexity is exacerbated if the continuation vehicle combines multiple assets from different funds with different terms. Accordingly, the risk for error is exponentially higher for continuation funds when processing capital allocations, tracking investor elections, calculating carried interest or reconciling in-kind contributions and distributions across multiple entities.

In short, continuation funds are bespoke and require bespoke solutions. Proper planning to identify the different requirements for each class of investors is critical to ensuring the job is performed correctly.

Published on: May 21, 2025