In this session, Ian Schwartz, Partner and Head of McDermott’s Investment Funds Practice, moderated a discussion that explored fundraising strategies and transaction structures that optimize liquidity and long-term returns from private equity funds’ strongest assets. Session panelists included:
Rob Campbell, Managing Director, Co-Head of Americas, Intermediate Capital Group
Tim Fitzsimmons, Managing Director, Lorient Capital
1. To help ensure that the audience was speaking the same language, Ryan Rohloff offered a brief description and overview of continuation funds and why they have become so popular in recent years. “A continuation fund, effectively, is a better mousetrap than doing a fund-of-funds sale or selling one of your best companies to another sponsor. You take an asset of any vintage and move it into a continuation fund that typically has a new lease on life from a duration perspective, follow-on capital, etc.” Rohloff also noted that continuation funds have been around for several decades, but for much of that time continuation funds were only applicable to sponsors as their funds reached 10 years old or were going into extensions. 2021 was the first year in which more than half of the continuation deals, or half of the overall market, were transacted out of funds that were six years old or younger.
2. Rob Campbell described the types of deals that his company is looking for, where they can act as the secondary player, and what they are looking for in terms of alignment with the general partner (GP): “We are very focused on alignment. We want to see evidence that the GP is a buyer alongside of us in the asset.” He also described what they don’t want to see: They are not pursuing transactions where the GP tested the M&A market and failed, and therefore pivoted to a continuation vehicle. On the other hand, the list of favorable elements that Campbell’s team looks for include a great management team in place, strong organic growth within the asset, and M&A serving as a catalyst (in the sense that the asset may have outgrown the size for portfolio construction within the flagship fund, they don’t have the dry powder to support that asset, or they’re out of their investment period).
3. Tim Fitzsimmons provided the GP/sponsor’s perspective on reasons to pursue a continuation fund rather than a traditional sale. Noting that his company operates in a smaller end of the market, he said that his company takes a two-fold approach to making the decision to pursue a continuation fund: “We look at it at the company level and at the portfolio, or fund, level.” As examples, Fitzsimmons mentioned multi-site healthcare services, clinical businesses focused on value-based care, and others, always with a view toward realigning investors for the next stage of growth and development of the company. He emphasized the importance of being clear about expectations for the next stage (e.g., duration or term of the investment opportunity, new exit strategy).
4. Ian Schwartz suggested that a continuation fund can help strengthen existing relationships between private equity sponsors and portfolio company management teams. Fitzsimmons concurred, saying “Many of these bubble up from the management team dynamic; they’re good assets and really good management teams, and as everyone knows, management teams are a leading indicator of the success of an investment.” A continuation fund allows that relationship and bond to continue. Rohloff noted that, from a process perspective, many of these transactions are relatively frictionless for management and allow them to continue executing on the plan. “These transactions allow you to provide management liquidity, reload them with a new management incentive plan, and really realign all constituents on the new cost basis, without having them go through the exercise that they would with a traditional exit.”
5. Garrett Hall pointed out a distinction between the continuation fund and M&A processes, noting that his firm spends a lot of time speaking with GPs in order to get a sense of the quality of the business so they can de-risk the process and build collaboration. Campbell underscored the importance of frank, early discussions so that investors can be pointed to appropriate opportunities and transactions that satisfied all players. Hall reiterated that multi-asset deals are much easier to negotiate and close than single-asset deals, and that secondary market demand is much deeper for the former—therefore, you should think more holistically and package multiple deals together, rather than pursuing a series of one-offs.
6. Fitzsimmons noted that healthcare has always been a specialist strategy and must respond to unique regulatory and other dynamics. That said, he added that the market is jam-packed, including new funds, spinouts, re-ups and more, so limited partners (LPs) are feeling strained right now. The public markets are likely to have an effect on fundraising and capital availability, and many LPs are waiting to see how things play out. Hall suggested that people open their minds to the new ways that capital is raised today (blindfold capital, secondary capital, etc.) and that these methods operate on different cycles. Continuation fund opportunities are worth exploring and, as Schwartz concluded, the area is only going to grow.