Alignment is critical to LPs accepting continuation vehicles

The proliferation of continuation vehicles has changed the discussion around fees between LPs and GPs, a conference has heard.

Speaking at PEI Group’s NEXUS 2024 summit on Thursday, Allen Waldrop, director of private equity at Alaska Permanent Fund Corporation, said he can get on board with management fees charged on continuation funds, as long as he understands the rationale for such transactions.

“The process to evaluate a single-asset continuation vehicle can be very similar to evaluating a co-investment, but the transaction starts in a different place,” Waldrop said. “There are important distinctions, and an argument on CVs is that you have to understand the rationale for it. For some, that makes complete sense and it’s a great structure, and there’s some [where] that make no sense at all and you would never do that.”

According to Waldrop, what’s especially interesting is that in continuation vehicles, the firm knows the business and management team well. “A lot of the risk you would see in a new transaction [isn’t] there… Some risk is certainly off the table, and you also have the management and GPs rolling [over their exposure] a lot. You got a pretty solid alignment relative to a traditional investment.”

Chris Eckerman, senior portfolio manager and head of co-investments at State of Wisconsin Investment Board, said continuation funds can be the “right tool for the right job,” although they may have been overused in some situations to date.

He added that some LPs might not have enough bandwidth – the right team or governance in place – to evaluate these opportunities within the appropriate timelines.

Todd Abbrecht, co-chief executive of Thomas H Lee Partners, noted that his firm has one cardinal rule on single-asset special purpose vehicles: “The solution pursued with the SPV must be the single best solution for the fund from which the asset comes.

“That process drives a very specific type of behaviour around the SPV. Often, in the single-asset SPVs we have executed, there’s been a pricing agent in the form of another GP,” Abbrecht said. “And in order to move the remainder of the exposure from the fund out, the buying third-party GP requires that we continue to be involved. If a substantial portion of that went to co-invest, that makes it not possible for us to devote the resources we need to the asset to continue to be successful. There are very specific origin stories around SPVs that, as they’re happening, make them the clear and right product as opposed to co-investment.”

Meanwhile, Anne Philpott, managing director for junior capital and private equity solutions at Churchill Asset Management, noted that co-investments and secondaries are complementary within her firm’s business.

“In most CVs, the dynamics are favourable – you have management that you’re familiar with, who typically roll their interest in the continuation vehicle… and they’ve done all of the heavy lifting. They bolstered the management team and they’re familiar with the nuances of the market so they’re able to take the business to the next level. That piece of the business is not competitive to our co-investment programme.”

What’s more, Philpott added that the firm is “very comfortable” with the more than 100 sponsors in their primary fund programme. “They have different strategies and target different sizes, and so not all of them are relying on CVs.”

The pervasiveness and the desire for co-investment will continue, noted Abbrecht.

“I don’t think we have [had] a conversation with an LP who doesn’t already have, or doesn’t expect to, as soon as practicable, launch some sort of co-investment program. And I think that’s a big change from five years ago, where there were many LPs who said, ‘That’s just not something we can devote resources to’… That’s a reflection of not only the offices of LPs, but [also that] they’ve now convinced their CIOs and boards of their institutions that co-investment is a good product for them.”

Beyond the reduced fee load, co-investments allow LPs to tilt a portfolio – whether that be in sector or geography – and to become better fund investors, according to Eckerman. “It allows us to build a window into these managers and their processes that we might not otherwise be able to do.”