The proliferation of Continuation Vehicles (CVs) in private equity, while presented as a new exit route, creates significant hidden conflicts and economic disadvantages for Limited Partners, potentially eroding industry-wide returns and the core value proposition of private equity.
Summary
Scott Ramsower, Head of Private Equity Funds at the Teacher Retirement System of Texas, shares a candid LP perspective on continuation vehicles (CVs). He argues that while GPs view CVs as an innovative exit strategy, LPs increasingly see them as 'conflict vehicles' that distort pricing, dilute alignment, and reduce potential upside. The conversation delves into 10 specific concerns, highlighting how CVs can undermine the traditional LP-GP relationship and the very structure of private equity investment, especially amidst a growing liquidity bottleneck.
Interesting ideas
CVs: A Fourth Exit That Benefits GPs More Than LPs. GPs celebrate continuation vehicles as a 'fourth exit route,' but LPs are far less enthusiastic because CVs introduce deep conflicts of interest. The GP acts as both seller and buyer, making true price discovery difficult and raising questions about whether LPs are getting a fair deal. This fundamental conflict is at the core of LP apprehension, despite GPs' initial excitement.
Hidden Economic Downsides for Rolling LPs. LPs rolling into a CV can unknowingly pay worse economics, such as higher effective management fees due to a re-based, inflated asset valuation, even if the headline fee rate seems lower. Additionally, carry structures can become less favorable, meaning LPs might pay more to retain an asset they already owned, eroding the original fund's expected returns.
Dilution of Mindshare and Alignment. Every hour a GP spends on a CV is an hour not dedicated to the commingled fund, diluting focus. Moreover, CVs create new revenue streams (fees, carry) for the GP, potentially misaligning incentives. The GP might win even if the original fund underperforms, violating the critical principle that LP and GP success should be perfectly intertwined.
Cannibalization of Co-Investment and Right-Tail Upside. CVs frequently absorb assets that would traditionally be sold to other sponsors, often involving fee-free co-investment opportunities for LPs. By moving top-performing assets into CVs earlier, LPs lose the 'right tail' upside—the potential for 5x, 7x, or even 10x returns—which is a key reason LPs invest in private equity, thereby potentially depressing industry-wide returns.
Zombie Funds and the Liquidity Crisis. A growing number of 'zombie funds' (funds unable to deploy new capital or exit existing investments profitably) are a looming problem. While CVs might help individual assets, they are not a systemic solution, merely kicking the can down the road. This prolonged liquidity drought forces LPs to deal with stranded assets and misaligned GP incentives for years.
Questions worth thinking about
How can the private equity industry evolve its fee and incentive structures to better align GP and LP interests, particularly in complex transactions like CVs?
Given the concerns around CVs and zombie funds, what alternative mechanisms could emerge to address the industry's liquidity challenges in a more transparent and equitable way?
If retail capital inflows increase, how will institutional LPs adapt their due diligence to ensure their interests are not further diluted or compromised by different investor priorities?
Written by AI from the episode's full transcript. It can get things wrong: if something here looks off, tell us at hello@podpings.com.
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