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In recent years, PE fund general partners have increasingly moved certain assets into continuation funds, which allow them to continue to hold the investments while offering limited partners the option to either roll-over their investments into the continuation fund, liquidate their investments or engage in some combination of both alternatives. However, a recent Institutional Investor article pointed out that LPs are concerned about the potential for abuse involved in these transactions, and that this has prompted the ILPA to issue new guidance for GPs and LPs on these transactions. Here’s the executive summary:

General Principles:

1. Continuation fund transactions should maximize value for existing LPs
2. Rolling LPs should be no worse off than if a transaction had not occurred

Rationale & Conflicts:

1. The GP should present the rationale for a continuation fund transaction to the Limited Partner Advisory Committee (LPAC), and should have explored alternative options for the selected asset
2. The LPAC should vote to waive conflicts of interest associated with the process of the transaction. GPs should bring all conflicts to the LPAC, whether or not conflicts are pre-cleared as per the LPA
3. A competitive process should be run to ensure a fair price was obtained; the process should include third party price validation
4. The GP should disclose the necessary information about the selected assets, the process, the rationale and the bids in a timely fashion to the LPAC when considering conflict waivers and to all existing LPs to facilitate roll or sell decisions

Process & Timing:

1. The continuation fund transaction process should conform with the relevant provisions of the existing fund LPA. GPs should avoid LPA terms that pre-clear conflicts of interest associated with these transactions
2. GPs should engage experienced advisors to facilitate the transaction. The GP should disclose any potential conflicts of interest with the advisor and the commercial arrangement. The advisor should be made accessible to the LPs
3. LPs should be afforded no less than 30 calendar days or 20 business days to make roll or sell decisions

Terms & Documentation:

1. Rolling LPs’ side letters should apply to the continuation fund where relevant. At a minimum, all relevant risk and governance terms agreed to in the existing fund side letter should apply
2. There should be no increase to the management fee basis or percentage for rolling LPs
3. There should be no increase to the carried interest rate or decrease to the preferred return hurdle
4. There should be no crystallization of carried interest for rolling LPs
5. All carried interest accruing to the GP related to interests from selling LPs should be rolled into the new continuation vehicle

Recommendations for LPs:

1. LPs should establish internal protocols to respond to these transactions, such as approval processes, underwriting processes and understanding statutory requirements
2. When transactions arise, LPs should work with GPs to set timing expectations around reviews, negotiations and approvals
3. When transactions arise, LPs should request that GPs provide documentation, models and materials necessary to be fully informed; there should be a symmetry of information between existing LPs and prospective new buyer

The ILPA document says that, in addition to the conflicted nature of these transactions, specific LP concerns giving rise to the need for guidance include the complexity of these transactions & the resulting time and attention required by LPs to evaluate them, the necessity for LPs to make decisions about individual assets in a fund, the speed at which these transactions are executed & the short period of time LPs have to make investment decisions about them.

– John Jenkins