Continuation funds—in which a firm sells a holding from an existing fund to a new one—emerged as a popular tool for managers to extend their hold period on specific assets, either to retain an attractive business or to avoid an unfavorable exit.

Limited partner concerns focus on possible conflicts of interest inherent in the structure of such transactions. The sponsor acts as both buyer and seller, negotiating on behalf of the existing fund while also representing the new continuation vehicle, which naturally raises questions about that sponsor’s ability to act in the best interests of both sets of investors simultaneously.

While management fees are often lower than traditional funds (around 1 percent), continuation funds also provide an opportunity for a longer tail of general partner fee generation as older funds wind down. These potentially favorable economics have led to speculation that self-interested sponsors may be pursuing continuation funds even when a traditional exit could provide more attractive returns.

Yet more criticism is directed at the use of continuation funds in down markets or for troubled assets, which some argue can allow GPs to avoid marking down underperforming assets, mask problems in their portfolios, and mislead both existing and new investors.

Continuation fund transactions have also trended toward more diverse structures. Over 50 percent of purchase agreements in 2023 included deferred payment mechanisms, allowing the acquiring fund to pay over a 6-12 month period. Performance-based earnouts are also becoming more common.

LPs say this added complexity can obscure the true economics of the deal and make it difficult to assess the fairness of the offer—especially when faced with a tight timeline to decide whether to cash out or roll into the new vehicle.

Continuation fund transactions do often require approval from the existing fund's limited partner advisory committee, a competitive sales process to determine fair value, and a fairness opinion from an independent advisor (newly mandated by the SEC last August).

Despite these safeguards, limited partners now appear to have lingering doubts.

Ares Management had to abandon plans for a continuation fund earlier this year after lukewarm investor reception. New Enterprise Associates (NEA) was also forced to reevaluate plans of its own following pushback.

Data from Evercore show continuation fund transaction volume fell 25 percent last year from a record $68 billion in 2021. Some of the drop may be related to broader market conditions, but there’s little doubt that investor appetite has soured on the structure: between 80 - 90 percent of existing fund investors elect to exit their position rather than roll over.