Continuing funds have grown rapidly in popularity in recent years as fund managers and investors seek to extract value from existing assets and take advantage of the dry powder available. This has boosted the secondary market as GPs move their investments into new funds and try to hold onto assets for longer periods.
With the pandemic’s slow M&A and IPO markets nearing the end of the car’s lifecycle, GP looked for alternative liquidity opportunities that were often still worth extracting. “Continuing funds” – often GP-led secondary vehicles structured as new funds set up to underwrite the assets of a fund nearing the end of its life cycle – have become a popular solution. No longer seen as a “zombie” funding vehicle Asset vehicles that are in jeopardy, struggling to make an exit, or unable to return their capital continuing funds will extract value from “trophy” assets. It has come to be seen as a way to keep withdrawing. “juice to squeeze”. Continuing funds offer the flexibility to retain assets when extracting more value or when exit timing is not right (given the macroeconomic and political climate) and GPs are already familiar , can be considered less risky than traditional funds. along with assets.
In addition to the benefits of GPs and LPs, portfolio companies are often keen to participate in continuing funds. This is because management typically cashes at least a portion of the exit-linked incentives in such transactions and does so. Without the hassle and uncertainty of a full-blown change of control/change of GP team they report.
In the United States, GP-driven trade, which accounted for less than 5% of secondary market volume in 2013, is growing rapidly to nearly 50% in 2020. funds. This type of transaction is expected to continue to grow, especially as economic uncertainty creates a disparity in expectations between buyers and sellers.
Recurring Funds are created through bespoke transactions and the structure is unique to each transaction. In many cases, a new vehicle will be created with the selected assets built into it. Investors in existing funds can choose to exit or continue with the new fund. New investors are brought in as needed to acquire equity in existing LPs and/or to provide new primary cash capital, subject to subsequent capital requirements of the subject portfolio.
Due to the structure of the deal, GPs also need to balance the competing interests of legacy and new LPs. In many cases, the terms of the deal are dictated by the terms of the existing fund, which may favor legacy investors. The creation of a new fund provides an opportunity to realign incentives that may have changed over the life of existing funds. Inherent in the structure of continuing funds is a conflict of interest that affects GPs, as GPs essentially control existing funds (sellers) and new funds (buyers). At a very basic level, investors who cash out want to see high prices/valuations to realize their return on investment. Buyers want low prices to better realize future value. GPs need to set a price that fulfills their fiduciary duty to current investors, yet is balanced and brings in new investments to complete the deal. As continuing funds become more popular, best practices have emerged to mitigate conflicts of interest and appease cautious investors. To be effective, these practices must be robust, fair and transparent and include: Communicate and clarify with existing LPs why this is the best/preferred option. We maintain transparency regarding the diligence performed and the economics proposed. Whenever possible, exchange information symmetrically. Carefully consider fees/transaction costs. Be aware of how fees and transaction costs affect both GPs and incoming and outgoing investors. What will be rolled over to the new fund? What will be extracted by the GP? GPs are often expected to commit cash to the new fund. How is that commitment structured?
Get a fairness opinion or independent evaluation. Obtaining a fairness opinion or independent evaluation can increase investor confidence in this type of transaction. In early 2022, the SEC proposed new rules under the Investment Advisers Act of 1940 aimed at increasing transparency to investors. Worth noting is the proposed requirement for advisors to obtain a fairness opinion from an independent opinion provider on certain advisor-initiated secondary transactions. The proposed rule states:
“We are not involved in certain advisor-initiated secondary transactions in which the advisor offers the fund investor the option to sell an interest in a private placement fund or exchange it for a new interest in another vehicle advised by the investor. I suggest that you seek an unbiased opinion from your advisor.” 2.
According to the SEC’s proposal, even if a GP has implemented a competitive sales process, it is more likely that a fairness opinion will be required. This requirement does not apply to advisors who, as proposed, do not require him to be registered with the SEC as an investment advisor (such as state-registered advisors and exempt reporting advisors). It is also proposed that record-keeping obligations for investment advisors be correspondingly strengthened to demonstrate compliance with the obligation to provide unbiased opinions and to ensure the independence of opinion providers (advisors or by disclosing any material business relationship to the LP). party has, or has had within the past two years, a relationship with an independent opinion provider), therefore the SEC is unable to exercise effective oversight and control over such new requirements. I can do it. This proposal explores alternative options for advisors to obtain independent evaluations.
“In lieu of a fairness opinion, the Commission may consider requiring advisors to obtain third-party evaluations in connection with certain advisor-initiated secondary transactions. We believe that the evaluation of the proposed transaction will require more attention to the proposed transaction as it relates to obtaining a fairness opinion. If these costs can be passed on to participants in these transactions, they may become unattractive to investors as a means of obtaining liquidity. There is 3
Many GPs seek fairness opinions in GP-led secondary trading as a matter of best practice and good corporate governance, even in the absence of legal requirements, to increase investor confidence and/or as a method of emissions already have a habit of Own Fiduciary Responsibility. In fact, ILPA recommends in its guidelines, GP-Led Secondary Fund Restructuring – Limited and General Partner Considerations, to obtain a fairness opinion from the LP in certain cases, especially in complex restructurings. Continued funding is here to stay and is being embraced by venture capital and growth funds beyond the PE world. With macro headwinds (accelerating inflation and interest rates, declining stock prices, energy crisis, etc.) valuations trending downward, continuing funds are a worthy strategy for both his GPs and LPs to consider. They provide options and valuable flexibility in complex and uncertain environments.
When it comes to constructing and implementing a continuing fund, it is important to emphasize the importance of experienced advisors on both the GP and LP side, able to navigate the pitfalls and complexities of such complex and bespoke transactions. cannot be overemphasized.