A Guide to Continuation Funds: Key Legal and Governance Questions for Private Equity Sponsors
Continuation funds allow private equity sponsors to retain selected portfolio assets beyond an existing fund’s expected life. Instead of selling an asset to an outside buyer, a sponsor can transfer it to a new vehicle, giving existing limited partners (LPs) the option to receive cash or maintain their investment through the new fund.
This structure can provide more time to execute a portfolio company’s growth strategy while offering liquidity to investors who want to exit. However, continuation fund transactions raise important legal and governance questions because the general partner (GP) often manages both the selling fund and the purchasing vehicle.
Sponsors must consider conflicts of interest, valuation, investor elections, disclosures, and transaction approvals. A clear process can help investors assess their options and enable sponsors to document the commercial rationale for the transaction.
1. Why Do Private Equity Sponsors Use Continuation Funds?
A continuation fund typically transfers one or more portfolio assets from an existing fund into a new investment vehicle managed by the same sponsor. The new vehicle has its own investment terms, capital structure, and expected holding period.
Sponsors may consider this approach when an asset has further growth potential, but the original fund is approaching the end of its investment horizon. The company may need additional time to expand into new markets, complete acquisitions, improve operations, or prepare for a future sale.
Continuation funds can also address different liquidity preferences among investors. Some LPs may want to realize their investment, while others prefer to retain exposure to the asset.
However, a continuation vehicle is not automatically the best option. Sponsors should compare it with alternatives such as a conventional sale, a partial exit, a fund extension, or another liquidity arrangement. The decision should reflect the asset’s circumstances, the fund’s governing documents, and investors’ interests.
2. How Should Sponsors Manage Conflicts of Interest?
Conflicts of interest are among the most significant governance concerns in continuation fund transactions. The sponsor may effectively sit on both sides of the deal: the existing fund sells the asset, while the continuation vehicle purchases it.
This arrangement creates competing economic considerations. A higher sale price may benefit investors in the existing fund, while a lower purchase price may benefit investors entering the new vehicle. The sponsor may also receive additional management fees or carried interest through the new structure.
Sponsors should identify these conflicts early and establish a process for addressing them. Key steps include:
● Review governing documents: Examine the limited partnership agreement (LPA), side letters, and other relevant documents for conflict-management, consent, and approval requirements.
● Engage the LPAC: Consult the limited partner advisory committee early enough for meaningful review, consistent with its authority under the governing documents.
● Document the rationale: Explain why a continuation vehicle is being considered and which alternatives were assessed.
● Disclose material conflicts: Identify relevant economic interests, affiliate arrangements, and differences between the existing fund and new vehicle.
● Maintain a clear record: Document material decisions, approvals, disclosures, and the steps taken to manage conflicts.
LPAC consultation does not automatically resolve every conflict or replace the sponsor’s responsibility to conduct an appropriate process. The committee’s authority depends on the governing documents, and its members may have their own interests in the transaction.
The Institutional Limited Partners Association (ILPA) continuation vehicle guidance provides a useful reference for early investor engagement, conflict management, and transaction transparency.
3. What Makes a Continuation Fund Valuation Defensible?
Valuation affects the proceeds available to selling investors and the entry price for investors rolling into the continuation vehicle. Because the sponsor has responsibilities to both vehicles, it should be prepared to explain how the proposed price was established.
A valuation review may consider:
● Recent financial performance and projected cash flows.
● Comparable company valuations and relevant transaction multiples.
● Market conditions since the original acquisition.
● Debt levels, capital requirements, and expected follow-on investment.
● Material business risks and changes in operating performance.
● Assumptions about the holding period and future exit strategy.
An independent valuation or fairness opinion may provide useful evidence, but neither automatically establishes that a transaction is fair. Sponsors should consider the adviser’s independence, the scope of its work, and the assumptions underlying its conclusions.
Where practicable, a competitive process involving credible potential buyers can provide useful price discovery. Sponsors should document the bids received, differences between offers, and reasons for selecting the proposed transaction.
A limited process is not necessarily inappropriate, but the sponsor should be able to explain why its approach was reasonable in the circumstances. Related-party participation, special financing arrangements, and preferential economics should also be assessed and disclosed where material.
The objective is to establish a defensible process that allows investors to evaluate the proposed price and transaction terms.
4. How Should Sponsors Structure Investor Elections?
Existing LPs are commonly offered an opportunity to sell their interests for cash or roll some or all of their investment into the continuation vehicle. The available options depend on the transaction structure and governing documents.
Investors need enough information and time to assess the new investment, particularly when the continuation vehicle has different fees, carried interest, governance rights, or liquidity provisions.
Sponsors should address three key considerations.
Clear election options: Explain what happens if an investor sells, rolls over, or does not respond. Identify any eligibility requirements, deadlines, and consequences of each choice. Clarify whether rollover requires affirmative consent or whether another arrangement applies under the governing documents.
Adequate review time: Investors may need to consult internal investment committees, legal counsel, and tax advisers. A realistic timetable and early access to transaction materials can support informed decisions. If material terms change, sponsors should consider whether investors need additional time.
Meaningful rollover terms: Sponsors should explain whether investors who remain invested will face different fees, carried interest, governance rights, or other material economic terms. ILPA guidance highlights the importance of a genuine status quo option for rolling investors.
The specific rights available to investors depend on the transaction documents and applicable law. Sponsors should not present a rollover as a simple continuation if it involves material changes to the investment arrangement.
5. What Should the Disclosure Package Include?
Disclosure should allow investors to understand the transaction, compare their options, and assess relevant risks. A general description of the asset and purchase price may not provide enough information for this decision.
A well-organized disclosure package should address:
● Investment rationale: Why the sponsor proposes to retain the asset, its current performance, its business plan, and the reasons for choosing a continuation vehicle over other exit options.
● Transaction process: How potential buyers were approached, what offers were received, and why the proposed structure and terms were selected.
● Valuation and economics: The proposed price, valuation methodology, fees, carried interest, transaction expenses, and other material economic arrangements.
● Investor elections: Available sell-or-roll options, deadlines, eligibility requirements, and differences between the existing fund and new vehicle.
● Conflicts and governance: Material conflicts, how they are being managed, and any required approvals or waivers.
● Risks and assumptions: Uncertainty surrounding projected performance, future capital requirements, exit timing, and valuation assumptions.
Information should be consistent across presentations, election notices, and transaction documents. Material changes should be communicated promptly rather than left for investors to discover during final documentation.
Sponsors can consult ILPA’s continuation vehicle resources when preparing disclosure materials and evaluating investor communication practices.
6. Which Legal Documents and Approvals Need Review?
The legal review should begin with the original fund’s LPA and side letters, but it should not end there. Sponsors must also consider the new vehicle’s governing documents and the agreements required to transfer the asset.
The original fund documents may address conflicts, affiliate transactions, investment restrictions, fund extensions, transfer rights, and the GP’s authority. Counsel should determine whether the proposed transaction is permitted and whether LP, LPAC, or other approvals are required.
The continuation vehicle’s documents should clearly establish its investment mandate, management arrangements, fees, carried interest, investor rights, reporting obligations, and governance procedures.
The asset transfer may require a purchase and sale agreement, contribution agreement, financing documents, or amended portfolio-company agreements. Existing debt covenants, contractual transfer restrictions, change-of-control provisions, and third-party consent requirements should also be reviewed.
Tax structuring and securities-law considerations may affect the transaction, depending on the fund structure, investor base, asset type, and applicable law.
A corporate attorney can help assess entity-level authority, approvals, and documentation. Sponsors may also need support from an M&A attorney in Century City when reviewing transaction mechanics, representations, indemnities, and closing conditions.
Identifying these issues early can reduce the risk of delays once the transaction timetable is underway.
7. What Governance Should the New Vehicle Have?
A continuation vehicle needs governance arrangements suited to its assets, investors, and expected holding period. Reusing the original fund’s structure without assessing the new circumstances may leave important questions unanswered.
Sponsors should consider:
● Investment authority: Who can approve follow-on investments, acquisitions, disposals, and significant changes to the business plan?
● Reporting: What financial, operational, and risk information will investors receive, and how often?
● Conflicts: How will affiliate transactions, allocation decisions, and competing investment opportunities be handled?
● Fees and expenses: Which costs will be borne by the vehicle, sponsor, portfolio company, or other parties?
● Exit planning: What assumptions guide the holding period, and how will investors be informed if the timetable changes?
● Investor rights: What voting, consent, transfer, and information rights apply?
Sponsors should also evaluate differences in rights between rolling investors and new investors providing capital. Any material differences should be documented and explained.
Good governance cannot eliminate investment risk, but it establishes a framework for making decisions, communicating with investors, and managing conflicts as circumstances change.
8. What Regulatory Considerations Apply?
Continuation fund transactions may implicate federal securities laws, investment adviser obligations, contractual duties, and state-law requirements. The applicable analysis depends on the transaction structure, the parties involved, and their regulatory status.
Sponsors should review investor communications for accurate descriptions of projected performance, valuation assumptions, material risks, and conflicts. Offering materials should not omit material information or present projections in a misleading way.
The regulatory status of the sponsor and its advisers also matters. Counsel should assess applicable registration requirements, compliance policies, recordkeeping obligations, and any relevant exemptions.
Sponsors should be careful not to treat vacated regulations as current requirements. The SEC’s 2023 Private Fund Adviser Rules, including the rule addressing adviser-led secondary transactions, were vacated by the U.S. Court of Appeals for the Fifth Circuit in June 2024. That outcome did not eliminate other applicable securities laws, antifraud obligations, contractual duties, or existing regulatory requirements.
The SEC’s announcement regarding the Private Fund Adviser Rules provides background on the vacatur. Counsel should verify the rules applicable at the time of the transaction rather than relying on outdated summaries.
9. Continuation Fund Pre-Closing Checklist
Before launching or closing a continuation fund transaction, sponsors should confirm that:
● The commercial rationale is clear and supported by evidence.
● Alternatives to the continuation vehicle have been considered.
● Conflicts have been identified and appropriately addressed.
● The valuation process is documented and defensible.
● Investors and the LPAC have received appropriate information.
● Sell-or-roll options and their economic consequences are clear.
● The election timetable allows meaningful review.
● Governing documents, side letters, and required approvals have been reviewed.
● Fees, governance rights, reporting duties, and exit expectations are documented.
● Relevant securities-law, tax, financing, and transfer issues have been assessed.
● Material decisions, disclosures, and approvals are recorded.
This checklist supports transaction planning but does not replace legal advice specific to the fund, asset, and investor base.
Building a Defensible Continuation Fund Process
Continuation funds can give private equity sponsors additional time to develop portfolio assets while offering liquidity options to existing investors. Their effectiveness depends on more than selecting an asset and agreeing on a price. Conflicts, valuation, disclosures, investor elections, legal authority, and governance must be considered together.
A transparent process helps investors assess their options and enables sponsors to document the commercial basis for their decisions. It also creates a clearer record of how conflicts were managed, pricing was assessed, and approvals were obtained.
At Alex Nahai Law, we assist businesses, investors, and sponsors with corporate, securities, transactional, and related legal matters. We can help review fund and transaction documents, assess governance and conflict-management provisions, and identify legal questions involved in structuring continuation funds. Contact Alex Nahai Law to discuss the legal and governance considerations relevant to your proposed transaction.
