Continuation Funds: A Powerful Tool for Investment Fund Sponsors

By John T. Murray, CPA, Partner

Continuation Funds: A Powerful Tool for Investment Fund Sponsors

Overview and tax considerations of continuation fund transactions

Continuation funds have emerged as powerful tools for investment fund sponsors, limited partners, and new investors offering a range of benefits and opportunities. This article outlines continuation funds, highlighting their key features, benefits, considerations, and tax implications.

What are continuation funds?

Initially, continuation funds were used by sponsors to help funds nearing the end of life to exit investments when there were few other sale opportunities. Over time, their usage has expanded significantly. Today’s continuation fund transactions serve multiple purposes, including:

  • Accessing additional capital
  • Resetting management incentive plans
  • Buying out co-investors
  • Providing liquidity, and
  • Crystallizing carried interest

In a typical continuation fund transaction, a new investment vehicle is established to acquire one or more assets from an existing fund managed by the same sponsor. This transaction allows limited partners in the existing fund to either cash out or retain their interests through an investment in the continuation fund. This flexibility is particularly valuable as each continuation fund transaction is unique, tailored to the specific needs and circumstances of the stakeholders involved.

The growing popularity of continuation funds

The appeal of continuation funds is evident in their growing popularity. In the first half of 2024, they represented approximately $71 billion of aggregate deal volume of which 44% were GP led. The success of the initial wave of continuation funds has spurred further interest and investment, suggesting a robust future for these transactions.

Types of continuation fund transactions

There are several types of continuation fund transactions, each with its own characteristics and benefits:

1. Full Fund Restructuring

The continuation fund acquires all or substantially all of the existing fund’s assets.

2. Multiple Asset Acquisition

The continuation fund acquires multiple, but not all, assets from the existing fund.

3. Single Asset Acquisition

The continuation fund acquires a single asset from the existing fund.

4. Strip Sale

The continuation fund acquires a specified percentage of one or more assets from the existing fund but does not acquire the entire interest in any asset.

Continuation fund transactions are not limited to the types above. A continuation fund can combine various attributes from the four types of transactions listed above.  Further, a continuation fund can acquire assets from multiple funds.

Key features

Continuation fund transactions are characterized by several key features, including:

  • Lead Investor’s Role: The lead investor, often the largest new investor, negotiates the terms of the asset transfer and the continuation fund itself.
  • Valuation or “Lockbox” Pricing: The price paid for the assets is typically set based on a specific reference date value, adjusted for contributions and distributions between the valuation date and closing.
  • Diligence: While alignment with the fund sponsor can reduce the need for extensive due diligence, recent trends show a move toward more comprehensive diligence practices.
  • Limited Indemnity and Representations and Warranties Insurance (RWI): Increasingly used to cover potential liabilities, providing greater security for new investors.

Planning and tax considerations

With careful planning and strategic execution, continuation funds can unlock new opportunities and drive substantial value for investment fund clients.

It is important to consult with advisors when considering a continuation fund. Each continuation fund transaction presents unique economic considerations. Fund managers must decide on the terms for existing investors, such as whether they can cash out or roll their investments into the continuation fund.

The transactions often involve complex tax considerations as well, particularly regarding tax-free roll options and the use of “blocker” corporations to manage tax liabilities. Involving tax advisors in the early stages can ensure the transaction is structured properly to avoid taxable events. For example, the partnership division rules under Section 708 and Treas. Reg. 1.708-1(d) govern the deemed steps for asset and partnership interest transfers. It is crucial that each step is structured to be tax-free, bearing in mind Section 754 elections in place for the predecessor fund and push-out elections under Section 6226 to manage imputed underpayments.

Conclusion

Continuation funds offer significant advantages for both private equity investment firms, private alternative investment funds, and investors, providing a flexible solution for managing investments in existing funds. As their popularity continues to rise, understanding the various types, features, and tax implications of these transactions is essential for maximizing their benefits.

If you are considering a continuation fund, Keiter can help you analyze and understand the tax implications and opportunities. Contact your Keiter Opportunity Advisor or Email our Financial Services team. | Call: 804.747.0000.

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About the Author


John T. Murray

John T. Murray, CPA, Partner

John provides customized insights and opportunities for fund managers and their clients, and fund administrators in areas such as fund formation and wind-down, tax structuring, complex tax allocations, Series Funds, Fund of Funds, Long-short Funds, Venture Capital Funds, Real Estate Funds and Hedge Funds.

He serves as the tax leader for Keiter’s Financial Services Industry team and is a member of the Mergers & Acquisitions team.

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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.

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