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Continuation fund transactions, where existing investors are given the option to sell or roll their interest in a legacy fund to a new fund managed by the same sponsor, have been a prominent feature of the private equity landscape for the last several years. Transaction volume has accelerated, and in the first half of this year, roughly $28 billion in assets were moved from one fund to another in general partner-led transfers, more than double the volume in the first half of 2023.

VRC’s private equity advisory practice has experienced significant growth from this volume of such transactions, usually undertaken to provide one group of investors with liquidity while buying time—and sometimes providing additional capital—to help growing portfolio companies build much-needed capital. This maximizes value for investors wanting to retain a stake in the investment(s) being transferred to a new fund.

Among the factors driving the growth in continuation fund asset transfers are limited partners’ desire for more liquidity, a sleepy IPO market, and the dramatic decline of de-SPAC transactions, both of which historically provided liquidity for PE portfolio investments.

A Regulatory Reprieve

The continuation fund phenomenon has yet to escape regulators’ attention. In a rulemaking for private funds finalized in August 2023, the Securities and Exchange Commission laid out guidance for sponsors on handling the transfer of assets between funds, including a requirement to obtain a fairness/valuation opinion from an independent provider for general partner-led secondary transactions.

The new regulations, including the fairness opinion requirements, were called into question in June when a three-judge panel of the U.S. Court of Appeals for the Fifth Circuit unanimously vacated the SEC’s private funds rule in its entirety. The SEC did not appeal the ruling, but securities law experts say subsequent Supreme Court cases that were decided after the Fifth Circuit ruling that rein in the federal government’s regulatory powers undercut the agency’s case and made a Supreme Court appeal less likely/less likely to succeed.

Best Practices Are Still Best Practices

Regardless of what happens in court, continuation transactions may have parties involved with potential conflicts of interest—GPs that have a fiduciary duty to both investors in the old fund and the new continuation fund; incumbent limited partners that want to cash out at a fair price; incumbent LPs that want to transfer their interest in the asset to the new fund and, finally, new LPs buying into the continuation fund. As such, despite the apparent regulation rollback, private funds that aspire to best practices should consider complying with elements of the Rule, including the provision for third-party opinions on fairness.

The SEC can be expected to continue scrutinizing—and potentially even ramping up scrutiny— private market activity. It has a litany of regulations that already apply to private fund sponsors and/or those distributing private investments to the public. Moreover, there is always the threat of civil litigation if limited partners believe the GP has violated its fiduciary obligations.

Fortunately, for most major PE funds, it’s business as usual. As we wrote shortly before the Private Fund Rule was finalized, in our experience, most sponsors were already seeking fairness opinions for significant inter-fund asset transfers as a matter of prudence, and we’ve seen no indication of this changing after the vacating of the SEC private fund rules in June.