The Private-Equity Maneuver Allowing More Investors to Cash Out

Continuation vehicles were once used by ‘zombie funds’ but now usually contain top-performing companies.

In April, private-equity firm New Mountain Capital agreed to sell Real Chemistry for $3 billion after owning the fast-growing medical-marketing agency for six years.

The Private-Equity Maneuver Allowing More Investors to Cash Out

The buyer: New Mountain Capital.

Real Chemistry is one of a growing number of companies being sold to a continuation fund, a vehicle that lets private-equity firms hold on to a business while giving investors in the original fund a chance to cash out.

Higher interest rates and uncertainty over tariffs have made many firms reluctant to sell companies or take them public, even after the typical five-year holding period. That has led their cash-starved investors to turn in droves to the secondary market to sell their private-markets holdings, typically at a discount.

But an uptick in sales by investors like pension funds and endowments isn’t the only reason the secondary market is booming. Private-equity firms themselves are also increasingly turning to continuation funds to give investors a way to cash out in a tough market. Sales to continuation funds accounted for a record 13% of private-equity exits globally in 2024, up from 5% in 2021, according to investment bank Jefferies.

Private-equity managers “need to manufacture liquidity in today’s environment, and the easiest route is really through continuation funds,” said Martha Heitmann, a partner on the secondaries team at LGT Capital Partners.

Continuation funds often contain just a single, top-performing company. These single-asset funds typically buy the companies from the original fund at the value where the private-equity firm has marked them or even for a small premium, investors and advisers say.

With Real Chemistry, New Mountain rolled its ownership stake, profits and some additional capital into a new vehicle with a five-year lifespan and gave its original investors the option to stay in. About 80% chose to cash out, earning four times their money, a hefty return for private equity, according to a person familiar with the matter.

The company’s cash flows grew sixfold to more than $250 million during the firm’s ownership, and New Mountain believes it can earn another four times its money, the person said.

New Mountain raised $3.05 billion from a group of secondary investors led by Coller Capital, a record for a single-asset continuation vehicle. In an unusual twist, about half of that will be used to pay out investors while the rest will finance Real Chemistry’s growth, including acquisitions.

Continuation funds returned a median of 1.4 times the initial investment net of fees, slightly higher than the returns for buyout funds, according to a March analysis by Morgan Stanley, which includes on-paper values for companies that haven’t been sold. They also had lower losses as a percentage of the initial investment than buyouts.

Continuation funds rose to prominence in the aftermath of the 2008-09 financial crisis, when firms were stuck with assets they couldn’t sell and didn’t have enough fee revenue to sustain their operations. These so-called zombie funds restructured into new funds with a new set of investors and renewed fees.

A decade or so later, firms began realizing they could use the same strategy to hold on to their best companies, earning another two or three times their money, instead of selling to a competitor. A tough market gives firms an additional incentive to use them.

Of the top 100 private-equity firms by assets under management, 70% to 80% have done a single-asset continuation vehicle, according to Nigel Dawn, global head of the private capital advisory group at investment bank Evercore.

The Institutional Limited Partners Association in 2023 introduced guidelines for continuation funds to address concerns, including about conflicts of interest. The recommendations included that firms provide a rationale for the move, give investors at least 20 business days to decide whether to stay in and allow them to rollover into the new fund at the same terms as in the original vehicle.

Firms with big businesses buying up investor portfolios also invest in continuation vehicles, including Blackstone’s Strategic Partners unit and Carlyle’s AlpInvest. But some advisers and investors say the amount of money raised for the strategy hasn’t kept pace with firms’ desire to use continuation funds. That has largely prevented them from being used to unload inferior assets, they say.

“There are so many firms that want to do this, and there is limited capital,” said Katrina Liao, a partner at Coller who focuses on continuation vehicles. “You can be so picky about what it is you want to go for.”

That could be changing.

To get exposure to companies that aren’t being put up for sale, a growing list of buyout firms—including TPG, Leonard Green and New Mountain itself—are launching strategies to focus on continuation vehicles.

Write to Miriam Gottfried at Miriam.Gottfried@wsj.com