Continuation funds are now a staple feature of the private funds industry as general partners (GPs) look to move one or more selected assets into a new vehicle which they can continue to manage. At the same time, GPs can offer limited partners (LPs) the option to roll into the new vehicle, sell their interest and take liquidity or a combination of both. Regardless of the market GPs can see upside from their use – in a downturn, GPs are able to hold on to assets until the market rebounds; and in an upturn, GPs can continue to share in the profit from a performing asset.
The Institutional Limited Partners Association (ILPA) which seeks to advance the interests of LPs and has been instrumental as a lobbying body has issued their latest guidance focused on continuation funds. The guidance is set on two general principles:
- continuation funds should maximise value for existing LPs; and
- rolling LPs should be no worse off than if a transaction had not occurred.
It goes on to set out a recommended process aligned with these principles and the fees that should be charged. By way of summary this includes:
- LPAC engagement - The GP should engage early with the LP Advisory Committee (LPAC) having first explored alternative exit options.
- Conflicts - All conflicts should be identified and then presented to the LPAC even if pre-approved in the LPA.
- Price - A competitive process should be run to determine a price, with the involvement of a third party price validation.
- Timing - LPs should be given no less than 30 calendar days/20 business days to make their roll v. sell decision.
- Fees - For rolling LPs, there should be no increase to the management fee or carried interest or decrease to the preferred return/hurdle.
- Carried interest - There should be no crystallisation of carried interest for rolling LPs.
- Fairness opinions - Fairness opinions are more frequently used in the US in continuation fund transactions (as compared to Europe) especially following the SEC’s proposal that they may require them. However, the ILPA guidance merely states that LPs might benefit from them. There is no recommendation they should be obtained in every scenario.
This list will not come as a surprise to those already managing or in the process of establishing a continuation fund as it largely reflects what is already being done (albeit it is applied with a degree of proportionality based on the size and makeup of the assets being rolled). As with ILPA guidance in the past, it is unlikely LPs and GPs will follow it verbatim but instead use it to support any arguments to further their commercial and legal preferences. For GPs it is useful to know of its existence and the potential that it may be brought up in discussions by LPs.