Key points

• In a continuation fund transaction the sponsor sits on both sides of the sale, so the process must withstand scrutiny from investors, regulators and, if needed, courts.
• Independent price discovery, usually a competitive process run by an advisor, with a fairness or valuation opinion, is the foundation of a defensible price.
• Existing investors should get a clear choice between selling for cash and rolling into the new vehicle, with enough time and information to decide.
• The limited partner advisory committee has a central role under most fund documents, but its approval does not replace a sound process and full disclosure.
• Fee and carried interest terms, crystallization of carry and the sponsor's own commitment are what investors focus on most.

Introduction

A continuation fund, sometimes called a GP-led secondary, is a vehicle formed by a sponsor to acquire one or more assets from an existing fund. Existing investors can take cash or roll into the new vehicle alongside new investors providing fresh capital. The structure has become a mainstream liquidity tool because it gives sponsors time to finish a value-creation plan and gives investors a choice. It also creates a sharper conflict than most private equity transactions: the sponsor advises the seller, controls the buyer and is often paid by both.

Why the conflict matters

Under the Investment Advisers Act of 1940, an adviser owes its clients a fiduciary duty that includes loyalty and disclosure of conflicts. Where the sponsor influences the price at which the old fund sells and the new fund buys, it must be able to show that the price was fair to the selling fund and that investors were told what they needed to know. In 2024 the Fifth Circuit vacated the SEC's private fund adviser rules, which would have required fairness or valuation opinions in adviser-led secondaries. Those rules are not in force, but the fiduciary framework is, and the market has kept the practices the rules would have codified.

Building a defensible process

Price discovery

A competitive process in which an independent advisor solicits bids from several secondary investors, with the lead investor identified through that process rather than chosen in advance, is easier to defend than a negotiated deal with one pre-selected buyer. Reference to alternatives, including a third-party sale or a continued hold, strengthens the record.

Fairness or valuation opinion

Funds now commonly obtain an opinion from an independent provider. It helps the advisory committee and investors but does not replace the process, and its scope, assumptions and the provider's fees and relationships should be disclosed.

The status quo option

Investors should be able to sell, to roll on the same economic terms as the old fund where possible, or to roll on new terms. Industry guidance, including the Institutional Limited Partners Association's 2023 guidance on continuation funds, encourages an election period of at least thirty days, often longer for complex assets, and a status quo or similar option.

The advisory committee and fund documents

Most partnership agreements require approval from the limited partner advisory committee, or LPAC, for affiliate transactions. Its members have their own conflicts, because many also invest in the new vehicle or other funds run by the sponsor, so they should receive the information needed to challenge the price, and minutes should show what was asked and answered. Sponsors should also confirm that the partnership agreement permits the transaction at all, including the investment period, term, transfer provisions and affiliate-dealing restrictions.

Economics and alignment

Investors scrutinize four sets of terms. First, whether the sponsor crystallizes carried interest on the sale from the old fund and whether it rolls some or all of that carry into the new vehicle. Second, the management fee and carry in the new fund, often lower than in a flagship fund, with a hurdle or tiered carry. Third, the size of the sponsor's own commitment relative to its proceeds. Fourth, the allocation of fees and expenses, including who pays for the process if the deal does not close.

Disclosure and tax

The election package should describe the transaction, the conflicts, the process, the alternatives, the valuation methodology and the sponsor's economic interest. Non-US investors, tax-exempt investors and insurers have different tax and regulatory positions on rolling and on cash, so parallel vehicles may be needed. Foreign investment review and merger control should be checked too, since moving a portfolio company to a new vehicle can be notifiable even when ultimate control is unchanged.

Practical points for sponsors

• Decide early whether the transaction is the best outcome for existing investors, and be ready to explain the alternatives.
• Retain independent advisors and agree their scope before they begin.
• Give the LPAC the full model, bids and fairness analysis, not a summary.
• Keep investor communications consistent and avoid pressure tactics around deadlines.
• Document the reasons for each term of the new vehicle.

Annika Holmgren-Reyes and Corvane Ryle's private equity team advise sponsors, secondary investors and limited partners on continuation funds and other fund-level liquidity solutions.