Why continuation funds are the new favourites in investor arsenals

Which is to say that while these firms can stay invested in successful portfolio companies even as the fund cycle nears an end, they can allow their backers, called limited partners, an exit route.

Multiples, a private equity firm, is in discussions to raise a continuation fund for its stake in Vastu Housing Finance, two people in the know told Mint.

Venture capital firms Kae Capital and Westbridge Capital are also considering similar moves, another person said.

"We are in discussion with institutional investors and waiting for market interest to build up before we open the fund to a larger set of local investors," said Anand Lunia, founding partner at India Quotient. 

Recently, Chrys Capital raised a $700-million continuation fund for its stake in the National Stock Exchange. Samara Capital raised a $150-million continuation fund last year, while venture capital firm Blume Ventures raised a ₹200-crore fund.

Multiples, Kae Capital and Westbridge Capital did not respond to Mint's request for comment on their plans.

What are continuation funds?

Continuation funds provide an exit for limited partners while allowing investment firms to remain invested in high-performing portfolio companies. These funds support trophy assets that need more time to reach their full potential beyond the typical fund cycle.

Since a fund life cannot be in perpetuity, as instructed by regulators, continuation funds offer an effective exit route for limited partners, giving them a level of certainty on the returns they will get. 

Continuation funds also eliminate the early risk factor for new investors, as they will know the assets they are going to be backing, as opposed to a traditional fund where a venture capital or a private equity firm, known as general partners, scout for new opportunities.

“There are quite a few continuation vehicles that are in the works," said Siddharth Shah, partner at law firm Khaitan & Co.

“This is an exit route that is being evaluated very proactively by several fund managers and limited partners because many are sitting at the end of a fund lifecycle with a few assets that still have some runway left for maximising their returns and hence present an opportunity in a CV," said Shah. “We expect to see a lot more of them emerge in the coming years."

Why continuation funds are gaining favour  

Other investors that Mint spoke with also concurred that continuation vehicles may become more popular. 

“Continuation vehicles (CVs) is a thing in your arsenal that you should evaluate as a viable exit option. This is a structure which will be used more often in India," said Gaurav Sharma, head of the India investment business at private equity firm Investcorp. 

While the private equity firm has evaluated such options, there are no immediate plans to raise one, Sharma said.

“The secondary markets globally are raising very large pools of capital with most of them concentrated in the US. There is still some scepticism in India as some secondary transactions that were made in the last 5-10 years have not always turned out too well for investors," Sharma said.

“That said, as the size of portfolios keeps growing and as the secondary markets pick up, there are opportunities to raise larger continuity vehicles in India."

Globally, nearly 10% of all distributions made to limited partners in 2023 came from continuation fund transactions, according to a report by Guernsey Finance.

Examples include early-stage investment firm Antler's $285-million fund, Investcorp's $185-million fund, New York-based Hildred Capital Management's $750-million fund, and Carlyle's $2.2-billion fund.

Also read | India Quotient’s Lunia expects funding winter for Indian startups to end this year

“VCs are in the business of backing ambitious founders chasing large markets and who can build large companies. The end outcome envisioned is getting mega returns on the risk capital invested," said Vikram Gawande of Blume Ventures.

However, the reality is that building such large successful companies is a 10+ years journey and by that time, most of the early-stage funds are towards their end of life, Gawande added.

"At this point, a fund manager is generally able to see that his/her successful companies can go public or be acquired in the next 3-5 years, but s/he is obligated to wind up the fund and deliver returns to the fund investors," Gawande said

“So, the choice s/he has is to sell the position in distress or believe in the conviction and hold the position for a bit longer. Continuation funds allow the fund manager to believe in his/ her conviction and hold the position for longer," he said, adding it's a win-win for everyone.

What it means for PEs and VCs in India going ahead

While the primary liquidity avenue has proven to be an initial public offering, exits in India will be a mix of mergers & acquisitions and secondary transactions which includes continuation vehicles going forward, he added.

Investors with exposure to India have witnessed tremendous growth in exit opportunities with secondary and strategic sales market growing manifold.

In 2023, secondary funds globally raised $3.2 trillion, a 92% jump from the year earlier driven by GPs and LPs needing to sail through the ongoing liquidity crunch, as per Bain's recent global private equity report.

Specific to India, 2023 was a marquee year for Indian exits even as deal-making activity slowed down. Bain's India report highlighted that exit value soared by about 15% to about $29 billion, accompanied by a rise in exit volume from ~210 to ~340 exits during the year.

India, which accounted for 20% of all private equity and venture capital investments last year, is increasingly playing a significant role in Asia-Pacific funding activity. Global investors like HarbourVest and Pantheon have also expressed optimism about investment opportunities in the country.

Pantheon's Kunal Sood also alluded to the improving exit avenues in India but believes that the appetite for continuation funds in the country is still in the early days with a long runway ahead. The investment firm alongside others anchored Chrys Capital's fund.

As LPs become more confident about exit routes in India, strategies like a continuation vehicle are coming of age.

“As startups raise large pools of capital, not every company will have the same time horizon to maximise their value… in sync with the fund life," Khaitan & Co’s Shah said, “so there will be more opportunities for such CVs to co-exist in India."