Private equity investments are known for their potential to generate substantial returns, but realising these gains often requires navigating a complex path to exit. Understanding the typical journey, as well as the role of secondaries and continuation funds, is crucial for both investors and fund managers alike.

A typical South African private equity fund would historically be structured as an en commandite (limited liability) partnership with a predetermined term, usually 10 years (plus two one-year extensions). The expectation of investors (LPs) is that, at the end of the term, the investments would be realised, and the investors would share in the returns.

Common investment exit routes for private equity funds include strategic sales to other companies, or secondary buyouts to other private equity firms. Secondaries provide liquidity and flexibility to investors while offering opportunities for new investors to access established private equity portfolios.

What does a fund manager do when the investments are performing well and trying to exit them at the end of the pre-agreed life of the private equity fund would diminish value rather than enhance it? Or if market conditions are not conducive to an immediate exit?

One practical solution is to set up a continuation fund.

What is a continuation fund? A continuation fund is a vehicle used to extend the life of a private equity fund beyond its original term. In a continuation fund, existing investors have the option to roll over their interests into a new fund structure, allowing the fund manager to continue managing the portfolio beyond the initial investment horizon. The continuation vehicle could be the same vehicle or a new partnership; there are many means to the same end.

Continuation funds are not new in the broader private equity market but have gained traction in African and Southern African markets.

Continuation funds offer several benefits. By providing additional time, continuation funds allow fund managers to optimise the timing of exits, potentially maximising returns for investors. They also enable further value-creation initiatives and strategic manoeuvres, enhancing the potential upside of the portfolio. Because investors can choose to participate in the continuation fund or exit their positions, it provides flexibility based on individual preferences and investment objectives.

Continuation funds however also give rise to questions around conflicts of interest and how the general partner and/or fund manager should navigate this. On this front, having a clear rationale for this form of exit, dealing with valuation methodologies, and managing investors’ exit expectations are key. Given that there is a lack of what constitutes ‘market practice’ for continuation funds, it also leaves investors uncertain as to how to deal with the details of a continuation fund. 

At the Annual AVCA Conference (2024), one of the panels tackled the topic ‘Charting New Horizons: Secondaries and Continuation Funds’. What was interesting in this discussion was the polar views that GPs and LPs held insofar as it related to continuation funds as an exit option.

The question arose as to the typical terms of a continuation fund, and although there is no clear local market practice yet, it is generally accepted that a continuation fund cannot be on the same terms as its predecessor fund. Aspects such as term, carry and fees would all need to be reconsidered. The panellists were however aligned on the importance of transparency during this process and that there needs to be a clear and coherent rationale as to why a continuation fund makes sense for the LPs.

In May 2023, The Institutional Limited Partners Association (ILPA) produced a continuation fund guidance, said to be developed alongside LPs, GPs and industry experts, which seeks to set out parameters on this front. Given the different factors at play and the unique nature of a continuation fund, ILPA does not seek to set out a gold standard, but rather to provide general parameters in these circumstances. The ILPA resource can be accessed here.

Navigating the path to exit in private equity involves a series of strategic decisions aimed at maximising returns and managing risk. We expect continuation funds to play a critical role in providing liquidity, flexibility, and value enhancement opportunities to the full investor base. Understanding these mechanisms empowers investors and fund managers to optimise outcomes in the dynamic world of private equity.