GP-Led Secondaries and Continuation Funds: Strategy and Regulatory Risks Analysis

What is a GP-Led Secondary?

GP-Led secondaries it’s a term used to describe a situation in which the General Partners (GPs) restructure or extend the life of one or more asset of the original fund. This may happen when some of the fund’s assets are not ready to be sold because they are either thought to be not yet mature enough or not as profitable as they would be in a longer time span than the usual Private Equity Investment period. When the GPs have identified which parts of the fund are suitable for this operation, they can start a process that will give the Limited Partners (LPs) a chance to cash out and benefit from their investment or decide to trust the GPs and continue the investment with a different vehicle called: continuation fund. This kind of strategy allows the GPs to retain the ownership of profitable assets without risk to sell them to the competition and it is also beneficial for all the parties involved: GPs can unlock a new liquidity path without selling those assets and therefore maintaining the ownership of still-profitable business, LPs may receive liquidity when portfolio realizations are delayed, Portfolio Companies avoid pressure for a liquidity event from board directors seeking to harvest investments at the end of the fund’s life and lastly New investors can access assets characterized by a mitigated risk and an accelerated path to investment realization. 

Types of GP-Led Secondaries

There are mainly two types of GP-Led Secondaries: the first type comprehends secondaries in which happen a transfer in asset titles to a new buyer or entity while the second type regard transfers in fund-level ownership that do not move assets out of the existing fund. 

The first category is made of three subcategories which are: 

• Wind Down: in this case we see a direct transfer of assets to buyer with no new vehicle created.

• Continuation Vehicle: LPs have the option from liquidity or rollover thus further increasing the time given to the assets to capture upside.

• Strip Sale: In this case we see a continuation vehicle where the fund partially sells a percent of all, or some assets and existing LPs retain upside while GP manages both existing and sold strip in the new vehicle. 

Whereas the second one is formed of: 

• LPA Amendment: Amend Limited Partnership Agreement) to extend fund or reset economics, giving assets more time to capture upside.

• Co-Sale: New Investor offers to buy interests from existing LPS at agreed price.

• Preferred LP Commitment: LPs provides new capital with preferred return for fund management or distribution, but it requires limited partners advisory committee approval to create separate LP class for preferred commitment.

Key Consideration Before Executing a GP-Led Transaction

Before starting a GP-Led Transaction GPs must consider some key factors regarding the pricing consideration such as: the potential buyers that may be interested in participating in the operation, if hiring a third party valuation agent would add value to the deal (in some cases an independent valuation can help “speed up” the whole process) and lastly if the deal is substantial enough to involve a banker (in some case they require that the purchase price must be at least an hundred millions in order to get involved). In addition to that GPs must pay attention also to the portfolio selection: the decision to get involved into a new transaction must take into consideration if the growth trajectory align with the portfolio original trajectory. On top of that the presence of near term exits that could attract buyers should also be checked. And finally, the portfolio balance must be evaluated to see if it is composed of high-quality assets and other components.

Why are GP- Led Secondaries and Continuation Funds Important?

As it was said before this kind of strategy allows the GPs to retain the ownership of profitable assets without risking selling them to the competition and it is also beneficial for all the parties involved.  

One example that could be made to describe how continuation funds can be important is the Ultimate Kronos Group merger: a software company that was born in 2020 from the merger of Ultimate Software and Kronos. 

Ultimate Software was a company specialized in cloud-based HR, payroll and talent management with a strong presence in mid-to-large enterprises whereas Kronos incorporated was a company leader in the workforce management market with a strong focus on timekeeping, labor analytics and scheduling. Kronos at that point had reached a stage of strong operational performance, recurring revenue growth and market leadership, but it was still offering a potential growth in the long term through product expansion and international scaling. 

The sale could have been made through a traditional IPO sale instead it was decided to pursue the creation of a continuation vehicle allowing existing investor to liquify their position if they wanted to while at the same time allowing the managers to retain control of a high-quality asset. Furthermore, the continuation vehicle gave the chance to benefit from an extended holding period while preserving the management, this made Kronos benefit from a strategic consistency, and a risk mitigated environment which brought new institutional capital from GIC (13) and CPP (14). 

Following the 2020 merger between the two companies, the resulting entity became a mature, cash-generative SaaS platform with strong recurring revenues and significant long-term growth optionality.  

It should be noted that these characteristics often conflict with the need for General Partners to realize investments within the contractual duration of their original funds, making it one the main issues when dealing in this environment because, as stated before, this kind of transactions intensify conflicts of interests due to the fact that the GPs act both as seller and buyer. GP Led secondaries are well suited for large and long duration assets and they work well, however their robustness depends strongly on how the governance mechanisms are implemented to avoid conflicts.

Market Analysis 

If we pivot our attention to the numbers, the market shows a promising pattern: in 2024 continuation-related buyout and growth capital exit value reached close to 45 billion representing 7% of distributions (4) with the total transaction volume set at 70 billion (9). If we have a look at the Schroders forecast, we can see that the growth of continuation investment is more structural rather than cyclical: in fact, the percentage of buyout distribution has only increased since 2013 when it was steady at 1%, four years later it was 2% and it has grown ever since reaching 7% in 2024 (9). The only year in which we witnessed a decrease was in 2022 when it fell from 2021 only to increase in 2023 reaching almost the 7% that has reached today. 

What drove this growth? Continuation investments are an effective and efficient way to continue company transformation: the management fees on continuation vehicles are roughly half of those traditional buyouts (9), the carried interest is also structured in tiers thus meaning that the overall fee burden is lower. In addition to that continuation investments generate faster liquidity and have more predictable return: Since managers continue to own their successful companies they are exposed to more mitigated risk that they would have been exposed to if they were to manage an unknown company, moreover continuation vehicles tend to deliver liquidity faster since they are characterized by a shorter hold period. (11) these are the reasons why Continuation market is set to quadruple in size by 2034 (9).

Even though continuation funds are widely used in private equity, If the market matures, we could see their adoption take place in private credit space. Unlike private equity, where continuation funds help extend ownership of high-growth assets, private credit structures differ a lot: it based on fixed-income instruments with defined maturities, making these funds less common. The lack of significant value appreciation of debt assets and predefined loan repayment schedules are among the reasons why private credit continuation funds are yet to be implemented in this market. (3)

Legal and Regulatory Considerations

Continuation funds can be relevant under a law-oriented scope as well: This practice involves a keen approach to avoid regulatory risks or problems of different kinds. One of the key problems involved in this situation is that GPs are on both sides and this situation may result in a conflict of interests where the GPs will keep higher fees or try to retain management of their assets. Another problem that LPs may face is that they are not going to be fully disclosed about risks involved in the transaction and its fairness moreover a major regulatory risk for continuation funds is one fund, or adviser may gain an advantage at the expense of another. This could happen through asset transfers that disproportionately benefit one party, biased valuations, or unfair expense allocations (7)

This situation has come to the SEC attention in 2023 (6), it made a press release regarding the “Regulation of Private Fund Advisers” which includes several new rules that would have been needed to be reviewed and integrated into the final list but were instead defined vacated on June 5, 2024, thus making them ineffective. First, the SEC goal was to “enhance transparency” and therefore making mandatory that private fund advisers will be required to register with the commission to provide investors with quarterly statements regarding fund fees, expenses and performance. Moreover, they’ll be required to obtain and distribute annual financial statement audit of each private fund they advise and a fairness opinion. In addition to that “private fund advisers will not be.

prohibited from engaging in restricted activities as long as they provide proper disclosure” this further affirmed the SEC position on the matter.

But the problems still stand so operators can adopt specific practices to avoid being prosecuted or face problem of any sort: For instance, they can review fund governance documents to ensure compliance with conflict-of-interest policies and LPAC (limited partner advisory committee) engagement. Moreover they may consider ocumenting investment decisions to demonstrate consistency with fiduciary duties and investment mandates, adhering to valuation policies, including third-party assessments to determine fair asset values and allocating transaction-related expenses fairly, aligning with disclosures and governance agreements. 

Lastly it is important to evaluate how the EU has legislated on the matter: the EU Directive 2024/927, which is yet to be implemented by members, states that under AIFMD managers must manage conflicts of interest, ensure fair treatment of investors and apply robust valuation processes a well. The last condition must be applied especially when moving assets between vehicles, by doing so the managers can ensure the fair treatment that the EU requires (12). 

In conclusion Continuation funds are indeed a great opportunity to take advantage of situations that at first glance may seem complicated; they are useful especially when an investment is yet to be ready to be sold or could be more profitable in a larger timespan. However, risks may arise but can be managed with effective strategies.  It is therefore important that all the people operating in the sector acknowledge both the positive aspects as well as the negative to be effective without risking regulatory issues.