Done well, a continuation vehicle can offer a solution for investors wanting to hold on to or access high-growth portfolio companies alongside a familiar manager, avoiding the need to exit before it reaches its full potential.
In this Q&A, Zach Jackson, Partner at QIC Private Equity based in our San Francisco office, delves into the benefits of continuation vehicles, the evolving market dynamics and the performance potential of these investment structures.
Key insights
- Growing market: The single asset continuation vehicle market has expanded significantly, yet remains underfunded, offering attractive investment opportunities.
- An attractive return profile: Continuation vehicles have shown the potential for better risk-adjusted returns, with research indicating higher median returns compared to traditional buyout funds1.
- Alignment is crucial: Successful continuation vehicles rely on the alignment between a high-performing portfolio company with an aligned incentive structure between General Partners (GPs) and Limited Partners (LPs).
Q. What are continuation vehicles?
A. Good private equity managers consistently drive performance in portfolio companies and align themselves with great management teams. Growth is rarely easy, linear or distributed evenly across a portfolio. So, when a manager catches lightning in a bottle, it makes little sense to part with the compounding equity and a management team that may take years to replicate in a new business. A duration mismatch because of longer hold periods, additional equity needed for the next phase of growth, and liquidity expectations of existing fund investors often result in the sale of a company (often to another sponsor) before the company has reached its full potential. A continuation vehicle is an investment structure designed to solve this conundrum.
When done effectively, the structure enables a private equity manager and their investors to reinvest in a business with considerable continued growth potential. At the same time, they provide an avenue for other investors to elect for liquidity at a compelling return, often materially exceeding the original base case.
Q. How do you do them well?
A. A sound investment thesis and alignment are crucial for successful continuation vehicles. This involves a rationale based on business fundamentals and favourable market dynamics. There should be a clearly defined use of proceeds, and a tangible growth story tied to the company's recent success. These companies have established market positions, strong management teams, and operate in growing economic segments, requiring more time to realise their full potential.
Alignment between the General Partner (GP) and new Limited Partners (LPs) is essential, with the GP showing commitment to the portfolio company by rolling capital and carried interest into the next phase of ownership. Generally, we see GP commitments approaching 10%, as compared to traditional buyout funds which are in the low to mid-single digits. There should also be alignment between economics and performance, with profit sharing tiered when specified return levels are reached.
Last, but certainly not least, transparency in process and fairness to existing investors in the fund must also be central to the goal of the transaction. This is critical. When GPs get this wrong, and they do, these continuation vehicles get a bad rap, for good reason.
Q. Why are continuation vehicles an attractive investment opportunity?
A. The continuation vehicle market is expanding yet underfunded. Single-asset continuation vehicle volume grew from US$2bn in 20182 to a peak of US$35bn in 20243, a 17-fold increase. The largest portion of the continuation vehicle market is single asset continuation vehicles, representing 65% of transactions, and 54% of all transactions falling under US$500m in size4.
Despite this, continuation vehicles accounted for only 13% of sponsor-backed exits in 20245, with market estimates suggesting a third of the deals fail6.
This gap between limited capital and abundant opportunity volumes means investors can maintain a high bar for performance, with only the worthiest assets securing backing from new investors.
Q. What is the risk profile of continuation vehicles?
A. Fundamentally, these investments provide access to a diverse set of high-quality GPs, proven management teams and a clearly defined plan of value creation. We believe this provides for better risk-adjusted returns. This diversification and continuity at the company present with lower risk when compared to a net new buyout where the sponsor is getting to know the business at the time of acquisition.
With that said, those interested in building exposure to continuation vehicles need a solid underwriting capability, a repeatable ability to positively select assets, and deal structuring competence. Pattern recognition and investment preference also lead to more conviction-based investing which can further enhance the risk return equation in portfolio construction.
Q. Where do continuation vehicles sit in a portfolio, and why use them?
A. Continuation vehicles are a strategic portfolio construction tool. The strategy can significantly enhance an investor’s portfolio returns relative to risk. It can also be a way to shore up duration and manage expected future program level liquidity given shorter hold periods of the vehicles themselves. In addition, these investments can be a way to fine-tune portfolio exposures, target specific sectors or geographies, and enhance overall portfolio diversification and return potential with high quality managers and companies.
Q. How do continuation vehicles perform?
A. Given there has been a robust level of activity, even pre-pandemic, investors have observable market results, which is useful.
The results of two studies indicate that investments made between 2018 and 2020 have achieved median returns ranging from 1.8 to 2.0x TVPIs and net IRRs exceeding 20% as of June 2024, about 40% higher than buyout funds from the same period7. It is also noteworthy that the upper quartiles also demonstrate higher performance, and more alpha compared to buyout funds of the same vintage. Continuation vehicles also demonstrate historically lower principal loss ratios compared to buyout funds, with just 8% of continuation vehicles delivering a loss of principal capital, versus 19% for buyout funds8.
Although it is difficult to pinpoint the exact reasons for higher relative performance and alpha, it is hard not to acknowledge that factors making continuation vehicles attractive contribute to superior returns.
Q. How does QIC Private Equity apply this strategy?
A. QIC Private Equity applies a thorough selection process designed to identify and access high-quality middle-market companies that are supported by thematic growth drivers and where we see potential for transformational value creation.
We align ourselves with skilled private equity managers who can significantly impact these smaller companies. We believe this offers a better path to creating a better risk-return profile leading to a more consistent potential for outperformance. Through this process, we aim to build a portfolio centred on capital partnerships that enable greater concentration in high-conviction investments, enhanced control over capital deployment, improved economic alignment, and lower loss rates.
Citations
- Morgan Stanley, The Case for Continuation Funds: An Initial Performance Review, January 2024 Evercore PCA Secondary Market Survey, 2022
- Evercore PCA Secondary Market Survey, 2022
- Lazard 2024 Secondary Market Report, January 2025
- Evercore Q2 2024 Continuation Fund Performance Report
- Jefferies Global Secondaries Market Review, January 2025
- Latham & Watkins, Innovation Required to Address Three Emerging GP-Led Secondary Transaction Themes, April 2023
- Morgan Stanley, The Case for Continuation Funds: An Initial Performance Review, January 2024 and Evercore Q2 2024 Continuation Fund Performance Report.
- Morgan Stanley, The Case for Continuation Funds: An Initial Performance Review, January 2024