Structuring private equity (PE) funds has generally followed a tried-and-tested process – a closed-end fund with a defined fund life – usually 10 years – where the first few years are focused on sourcing and deployment, followed by a period of portfolio management, and finally the time taken to exit the investments through IPOs, secondary markets, or trade sales. However, following the unceremonious onset of the COVID-19 pandemic, PE as an asset class has seen significant value dislocation1, with investment timelines interrupted and exit potential dampened. Amidst this disruption, limited partners (LPs) are still focused on exit liquidity, bound by mandate and/or investing discipline, which presents a conundrum for general partners (GPs): providing liquidity to their LPs at the end of the fund’s lifespan when it may make more sense to hold the assets until valuations revert to or reach their desired levels.
In comes the continuation fund, a vehicle designed to take on the assets from a current fund by the same GP that is approaching the end of its fund life. Through this fund structure, GPs offer their existing LPs the option to realise the market value of their investments or double down on the portfolio in the hope of making bigger returns at a later date. That said, despite being accorded the luxury of choice between cashing out or staying vested, existing LPs are not the only potential beneficiaries from the continuation fund model. New LPs who invest in the continuation fund can evaluate the potential upside of an already established asset and have greater certainty around their assessment; the investment risk, essentially, is lower than that in a primary fund2.
The concept of a continuation fund is hardly new; over a third of PE’s 50 biggest firms, including Blackstone, KKR, and TPG3, have launched such funds to create liquidity by buying their own portfolio companies. However, the structure has gained traction in Southeast Asia in recent months: August 2021 saw Malaysia-headquartered Navis Capital Partners close its US$450M Navis Asia Green Loop Fund to make secondary acquisitions of five portfolio companies in its Navis Asia Fund VI, while Vertex-led Vertex Legacy Continuation Fund Pte Ltd commenced operations in December 2020.
Useful as they are, continuation funds are in no way turnkey solutions and are usually tailored to the needs of a particular situation. In some cases, a number of portfolio companies will be transferred to the continuation fund, while others will involve strip sales in which the fund manager sells parts of different assets to the new vehicle. GPs must also balance the interest of multiple stakeholders4, including new and old LPs.
Notwithstanding their relevance within the current pandemic environment, continuation funds are also viewed in Southeast Asia as an opportunity to tap the region’s growth trajectory. While PE funds typically have holding periods of five to seven years, Southeast Asian companies, especially institutionally backed ones, can potentially grow at 20% or more for over a decade5. For GPs in this region, it is becoming increasingly sensible to explore avenues that enable them to see this growth through until the companies are ready for an exit.
While once denigrated as a way to restructure troubled PE funds, continuation funds have shaken off their stigma and put on a new mantle as an effective tool for proactive fund management. As Southeast Asia-focused funds begin to grow in number and scale, and GPs seek more innovative and flexible solutions, the structure may one day find its way as a mainstay in the region’s PE playbook.
Best regards
Nicholas Tan
Associate Director - Private Equity
Sources
1 Private Equity Insights - The impact of Covid-19 on Private Equity Markets (June 2020)
https://pe-insights.com/news/2020/06/29/the-impact-of-covid-19-on-private-equity-markets/
2, 5 DealStreetAsia - SE Asian GPs spot big promise in continuation funds amid pandemic drag (August 2021)
https://www.dealstreetasia.com/stories/continuation-funds-se-asia-255042/
3 Private Equity International – Which top PE managers have used continuation funds? (August 2021)
https://www.privateequityinternational.com/which-top-pe-managers-have-used-continuation-funds/
4 Pitchbook - Continuation funds: How GPs are holding on for longer (February 2021)
https://pitchbook.com/news/articles/continuation-funds-secondaries-gp-buyouts
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