Private Equity Spotlight: "SI Decade: Zombie funds to continuation vehicles"

Date: April 22, 2024
Host: Adam Ley (Senior Editor, PEI Group)
Guests: Nigel Dawn (Global Head of Private Capital Advisory, Evercore), Vern Perry (Leads Blackstone Secondaries Business), Harold Hope (Global Head of Secondaries, Goldman Sachs Asset Management)

Main Theme & Purpose

This episode examines the evolution of language, practice, and perception in the private equity secondaries market, especially the transformative shift from "zombie funds" and "fund restructurings" to "continuation funds." The host explores how changes in terminology mirror real structural and incentive changes in the industry, how continuation vehicles are used today, what makes them effective or risky, and what the outlook is for further growth.

Key Discussion Points & Insights

1. The Evolution of Industry Language

• From Negative to Positive Framing
  • Early secondaries were often called "fund restructurings" or housed in so-called "zombie funds"—terms implying failure or underperformance.
  • By 2018, the term "continuation fund" began replacing older language, reflecting a more neutral or positive outlook.
  • Adam Ley: "I can see why the word continuation has more of a neutral—you might even say positive—meaning than restructuring, which generally suggests something has gone wrong..." (01:28)
• Market Impact
  • Continuation funds are now mainstream, with the market growing to ~$40 billion annual trading volume.
  • Among the top 20 private equity firms in the PEI 300, more have used continuation funds than haven't.

2. Early Days and Initial Skepticism

• Nigel Dawn’s Story (02:22)

  • Dawn’s attempt to start a secondaries advisory was called “the single worst idea” by an industry peer, indicating the skepticism that existed just a decade ago.

• The Technology of Asset Transfers

  • The mechanics of moving assets from one vehicle to another ("the technology") date back to at least 2006 but were relatively novel for GPs, less so for LPs. (03:02)

3. Changing Use Cases and GP Incentives

• From Needing More Time to Wanting More Time
  • Vern Perry: "The zombie fund really described a situation where a GP had run out of time, had run out of incentives... The most important part is they needed more time." (04:12)
  • Now, top GPs use continuation funds not because they need more time to fix poor assets, but because they want to hold on to star performers that continue generating value.
• Less Seller Regret
  • GPs regret selling their best assets just to fundraise for the next fund and now view continuation funds as a way to avoid that.
  • Nigel Dawn: "Rather than be forced into selling prematurely, I want to give an opportunity both to my existing investors and potentially new investors to participate in the next leg of growth..." (05:39)

4. Why “Continuation Fund” Fits

• Both guests agree the new term better describes what the structures allow for.
• Vern Perry: "It's to me precisely describes what is happening when you think about this setup... it's performed wonderfully, they know the management, they've already pulled the valuation levers, a lot of the valuation has come through, but there's a lot more valuation upside to come." (06:51)

5. Conflicts of Interest and LP Frustrations (08:07)

• ILPA’s View: Continuation fund transactions are "inherently conflicted, with GPs sitting on both sides of the transaction."
• Historical Frustrations: LPs felt disadvantaged before best-practice guidance—highlighting the need for standards.

6. When Continuation Funds Don’t Make Sense

• Vern Perry’s Criteria:
  • GP has held the asset for less than two years.
  • Plenty of time remains in the fund life.
  • Asset underperformed (e.g., held at a 0.8 MOIC over six years).
  • Poor GP alignment (e.g., GP doesn't reinvest in the continuation fund). (09:07)
• Nigel Dawn’s Addition:
  • Failures to sell or unmet valuation expectations indicate continuation isn’t appropriate. (10:13)

7. Ingredients for Success

• Quality, Alignment, and Growth Story
  • Nigel Dawn: "Is the GP great? Have they performed over time? Do the buyer community know them and trust them? ... If you have a GP who doesn't want to roll any of their capital into the transaction, that should be a huge red flag." (11:02)
  • Alignment, credible strategy, and ongoing GP investment are critical.

8. Returns, Expectations, and Risk

• Debate over what returns LPs should expect:
  • Early industry data show positive signs but continuation funds are still young.
  • Nigel Dawn: “Given that positive selection bias... we would expect that would provide good private equity returns.” (13:35)
  • Vern Perry: Stresses risk-adjusted return, not just raw IRR or MOIC: “The standard deviation on that should be lower, the risk should be lower.” (14:26)

9. LP Choice, Flexibility, and Option Value

• Adam Ley: “It’s important to take into account the fact that the concept of secondaries is to mitigate blindfold risk because you already have exposure to existing assets.” (15:26)
• Nigel Dawn: “…Options provided to LPs need to be good... the alternative is the GP just sells the asset and then the LP doesn't have any choice at all. So in some ways this is an enhanced option for an LP...” (16:39)
• Vern Perry: Highlights the value of optionality and that LPs reinvest liquidity elsewhere, so the opportunity cost isn’t the full magnitude of a missed future MOIC. (17:24)

10. Growth, Constraints, and Outlook

• Market Growth
  • UK mid-market GPs now prefer continuation funds for exits over IPOs or auctions (18:18).
  • PEI LP survey: 50% of LPs invest/have interest in backing these funds (up from <40% last year).
• Key Constraints
  • Vern Perry: “The big constraint on the growth in this market is capital, frankly.” (19:11)
  • Nigel Dawn: Performance will attract more capital.
• Future Outlook
  • Harold Hope: “Still a lot of room for growth because the people that are in this industry really view themselves as having a mandate of being a liquidity provider, very broadly defined...” (20:01)

Notable Quotes & Memorable Moments

• On the shift in language:
  • "I can see why the word continuation has more of a neutral—you might even say positive—meaning than restructuring, which generally suggests something has gone wrong."
    — Adam Ley (01:28)
• Industry skepticism:
  • "It was the single worst idea he'd heard that year."
    — Nigel Dawn (02:22)
• On GP motivations shifting:
  • "They want more time because it's been a gift and the gift keeps on giving."
    — Vern Perry (04:12)
• On regret from exiting too soon:
  • "So there's a sense that I've done all the hard work with the asset... Rather than be forced into selling prematurely, I want to give an opportunity... to participate in the next leg of growth."
    — Nigel Dawn (05:39)
• On the duality of the decision for LPs:
  • "They could take their basis off the table. So the options provided to LPs need to be good and the alternative is the GP just sells the asset and then the LP doesn't have any choice at all."
    — Nigel Dawn (16:39)
• On the importance of risk-adjusted returns:
  • "I would argue that the standard deviation on that should be lower, the risk should be lower."
    — Vern Perry (14:26)
• Future market opportunity:
  • "I actually think there's still a lot of room for growth because I think the people that are in this industry really view themselves as having a mandate of being a liquidity provider..."
    — Harold Hope (20:01)

Timestamps for Key Segments

| Timestamp | Segment / Topic | |-------------|--------------------------------------------------------------------| | 00:01–02:22 | Opening, shift in language: “zombie funds” to “continuation funds” | | 02:22–03:29 | Nigel Dawn’s origin story in secondaries | | 03:29–05:17 | How mechanics and incentives changed from 2006 to 2014-2018 | | 05:17–06:51 | GP perspectives on holding vs. selling assets | | 06:51–08:07 | Seller regret, why continuation naming makes sense | | 08:07–09:07 | Conflicts of interest for LPs, ILPA’s guidance | | 09:07–10:48 | When continuation funds are a bad fit | | 11:02–12:29 | Ingredients for a successful continuation fund | | 12:29–15:26 | Returns: data, expectations, risk vs. reward | | 15:26–18:18 | LP options, opportunity cost, value of liquidity | | 18:18–19:56 | Market growth, constraints, performance-driven capital flows | | 20:01–20:24 | Harold Hope on innovation and industry room to grow |

Conclusion

This episode offers a nuanced, historical, and strategic look at the meteoric rise of continuation funds within the private equity secondaries space. With a focus on how language, incentives, and deal structures have adapted over time, expert guests draw sharp distinctions between the old and new paradigms in secondaries. The discussion is rounded out by practical guidance on when and how continuation funds add value, new industry data, and the challenges and opportunities facing both GPs and LPs as the market matures.

For further reading, listeners are directed to deep dives on secondariesinvestor.com and PEI Group’s publications.