Private Equity’s New Exit Playbook – CFA Institute’s Entrepreneurial Investor

Private equity (PE) exit strategies have adapted and evolved from the days of smooth IPOs and rapid mergers and acquisitions, including follow-on funds. The backdrop of low funding costs that led to record transaction volumes, rapid fund turns and steady exit opportunities has evaporated over the past five years. In the current environment of high interest rates, exit options have become smaller, financing has become more expensive and terms have become longer. Last year, the average buyout period rose from 5.7 years to 6.7 years, with the exit gap now greater than at any time since 2005. according to research by McKinsey.

Enter the follow-on fund, which has quickly evolved from niche to mainstream, offering opportunity to many investors while inviting caution from others. The emergence of follow-on funds reflects a structural evolution in private equity rather than a temporary adjustment. A relatively new addition to the PE ecosystem, these funds enable liquidity in a capital-constrained world while testing the boundaries of transparency and governance.

Insight into continuation funds

A follow-on fund allows a PE firm to transfer one or more portfolio assets from an existing maturing fund to a new vehicle, often managed by the same general partner (GP). Existing limited partners (LPs) can cash out or contribute them to the new structure, while new investors can acquire stakes in mature, high-performing assets with shorter investment periods.

The market for follow-on funds has grown rapidly. In 2024, 96 such vehicles were registered, an increase of 12.9% year-on-year, which amounts to 14% of all PE exits. Single-asset continuation funds, such as the $3 billion deal with Alterra Mountain Company, underscore their growing size. Analysts at Greenhill & Co. predict that continuation funds could account for 20% of PE exits in the coming years, driven by a maturing secondary market and challenging exit environments.

Why the turnout?

All this has slowed down strategic mergers and acquisitions. In 2023, global mergers and acquisitions recorded the lowest level in a decadeunderscoring the post-pandemic slowdown in dealmaking. Global The number of PE outlets decreased to 3,796 from the 2021 peak of 4,383. While not at its peak, global PE dry powder is still around $2.5 trillion From mid-2025 onwards, the pressure to deploy capital will remain high, even as exit channels become tighter. Several forces underlie the recent proliferation. Among them: a lack of traditional exit options, a looming maturity wall and a need for LPs to free up cash.

First, rising financing costs have limited leveraged buyouts and widened the bid-ask gap in mergers and acquisitions. Follow-on funds allow managers to hold high-conviction assets and provide investors with liquidity options. The approaching maturity wall is another factor. More than 50% of PE funds are now six years old or older, while 1,607 funds will be phased out in 2025 or 2026. Continuity funds enable companies to expand value creation without forced sales.

Finally, these funds meet investor demand for flexibility. LPs can exit for immediate liquidity or roll over to pursue future upside. New investors gain exposure to proven assets with lower blind pool risk. Continuation funds brag a loss ratio of 9% compared to 19% for buyouts, which offer better risk-adjusted returns.

The benefits: a win-win-win situation?

Proponents argue that continuation funds benefit all parties involved: GPs, existing LPs and new investors. For GPs, this expansion allows them to continue managing high-performing assets, generating ongoing management fees and carried interest.

LPs gain liquidity without sacrificing potential upside, while new investors gain access to mature assets with a clearer path to returns. Recent analysis shows that continuation funds have outperformed buyout funds in terms of multiple-on-invested-capital (MOIC) across all quartiles, while also showing lower loss ratios.

Empirical evidence supports their appeal. Morgan Stanley found that continuation funds were in the top quartile achieved a MOIC of 1.8x, compared to 1.6x for comparable buyout funds. Industry-specific examples, such as Lime Rock Partners’ use of continuity structures in energy assets, illustrate how managers can extend value creation through market cycles. The companies have used continuation funds to expand their ownership of assets in less favored basins, betting on future market shifts. This flexibility can turn a good investment into a great one, especially when market timing is less than optimal.

Risks and governance challenges

Despite their benefits, continuation funds have raised concerns about governance and valuation. When GPs act as both sellers and buyers, conflicts of interest are inherent. Investors have raised eyebrows at the nature of these transactions, with critics likening them to circular financing structures if not carefully managed. To better understand these dynamics, read the CFA Institute Research and Policy Center report Continuation funds: ethics in private markets.

Transparency in valuation is also essential. LPs must be confident that the purchase price for transferred assets reflects fair market value. Many companies tackle this by using external financial advisors for unbiased opinions or by holding auctions to ensure market-driven valuations. Yet LPs often lack the resources to thoroughly vet these deals, and the concentrated risk of single-asset funds (vs. diversified secondaries) can deter rollovers.

These concerns are becoming even greater the Fifth Circuit Court of Appeals’ 2024 decision to vacate Portions of the SEC’s Private Fund Advisers Rule have removed mandatory fairness opinion and disclosure requirements for follow-on funds. This ruling reduces mandatory reporting requirements, potentially increasing conflict risk as GPs face less regulatory scrutiny, but also allowing for faster execution of transactions. It also increases pressure on investors to conduct thorough due diligence, underscoring the need for voluntary and robust governance.

Best practices for investors

For those involved in continuation funds, several best practices can reduce risks and improve results:

1. Ensure independent appreciation: : Request third-party appraisals from reputable advisors, such as Houlihan Lokey or Evercoreto verify fair asset prices and seek auction processes where possible. LPs should request detailed pricing methodologies and comparable transaction data.
2. Align GP and LP incentives: Require GPs to roll over 100% of their investment and negotiate carried interest and management fee structures that balance long-term alignment and investor protection.
3. Assess concentration risk: Single asset continuation funds can introduce increased exposure; investors should compare their risk-return profile with diversified secondary funds and conduct stress tests under adverse market conditions.
4. Negotiate governance early: LPs should negotiate the terms of the continuation fund during initial fund formation, setting clear expectations for pricing, governance and LP options. Establish LP veto rights or advisory roles in initial fund formation to ensure influence over future follow-on transactions.
5. Make use of specialist expertise: Engage advisors experienced in secondary and GP-led transactions to assess valuation methodologies, cash flow models and regulatory implications.
6. Track performance after the transaction: Requires transparent, periodic reporting on operating and financial metrics to confirm that extended holding periods generate additional value.
7. Participate in an active dialogue: Promote open communication with GPs to address concerns about conflict or transparency. Participate on LP advisory committees to influence governance and ensure accountability. Active involvement can deter self-dealing and promote fair outcomes.

The new, new PE normal

For investors, success in this environment depends less on the structural novelty of the vehicle and more on the accuracy of its supervision. The lesson from both the zero interest rate expansion and the current high interest rate adjustment is clear: in private markets, value creation can only sustain if coordination, transparency and discipline make it possible.