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Except LPs aren't stupid. They probably won't keep going with this if it doesn't pay off. They're not Joe Boomer deciding he needs to diversify from his 60/40 b

Except LPs aren't stupid. They probably won't keep going with this if it doesn't pay off. They're not Joe Boomer deciding he needs to diversify from his 60/40 blue chips and bonds, they're high net worth individuals and institutional investors who are either 1. Being stupid and getting what's coming to them or 2. Getting greedy and getting what's coming to them.

pevey 4y ago
The rationale that is usually given to LPs to make them go along is that the time to exit is not right, but the one fund that currently owns the interest is getting long in the tooth, so they need to move the interest to the newer vintage year fund. They spin it as, we thought it was a good investment before, and we think it is an even better investment now, so we want to hold onto it. But we still need to wind down the old fund. It's a nightmare from a valuation standpoint, because while many LPs may well be invested in both funds, making it a wash, some are not. The LPs that invest in both funds sign a check to fund the investment in the new fund, and then get the money back as the older vintage is winding down. The investment just essentially gets rolled forward. The investors who are only in the new fund are cashing out the previous investors, so this is much more of a concern. But they are new and still usually riding the feeling of wow, they let me invest in this awesome fund. PE firms are really good at creating an aura of exclusivity and luxury. A rolling loan gathers no loss. So long as the music keeps playing, valuations can be whatever number you can get your auditor to agree to. Nice dinners and event tickets for your audit partner can help with that.
- _uy6i 4y ago
  Except I think in the case where I’m an LP in both funds I potentially pay an incentive fee in Old fund even if the value defines dramatically in new fund, so still could be bad for me
  - pevey 4y ago
    This is true, it cashes out the carried interest as well, so if the new fund closes with a lower valuation for that investment, the investor was screwed out of more carried interest than should have been paid.
- collegeburner 4y ago
  It's not a "right time" argument, I've seen people place these and they're usually pitched that this is a "real winner" and there's a bunch more growth left if they stay invested. That's why they're moving towards single-company funds. And sometimes they're right tbh. And tbh there would be some other LPs cashing out the previous investors if the company was sold normally. The only LPs who take this risk are the ones who buy into the new fund. And if they're worried they should just check the GP commit, if it's thin then obv they're just pulling fees so don't invest. Some of the continuation funds the GPs actually believe they have a really good investment and they increase their commit as a %. And the increasing valuations you describe are literally the same as the public markets the past few years. No bribing audit partners required.
miketery 4y ago
LPs are usually pension plans, endowments, or family offices. The stewards of these have different incentives than the ones that are tied to the capital.
yieldcrv 4y ago
LPs don't have a say. Their ability to withdraw/redemption is often heavily constricted too. (I’m not making an opinion on GP behavior yet)
- collegeburner 4y ago
  Uhh yeah they do. Maybe it's technically the GPs decision but I have watched GPs get their asses chewed by LPs and make a different call after those kinds of meetings. More importantly literally all LPs have to do is not invest in the continuation fund. It costs them 0 money extra to close out their position in the old fund and leave. Continuation funds are 100% optional. Also IMHO continuation funds can be useful if a PE firm thinks it has a real winner. It's harder than you think to find good places to place a lot of money so it will grow so I can understand why LPs might go for it in some cases.

pevey 4y ago

The rationale that is usually given to LPs to make them go along is that the time to exit is not right, but the one fund that currently owns the interest is getting long in the tooth, so they need to move the interest to the newer vintage year fund. They spin it as, we thought it was a good investment before, and we think it is an even better investment now, so we want to hold onto it. But we still need to wind down the old fund. It's a nightmare from a valuation standpoint, because while many LPs may well be invested in both funds, making it a wash, some are not. The LPs that invest in both funds sign a check to fund the investment in the new fund, and then get the money back as the older vintage is winding down. The investment just essentially gets rolled forward. The investors who are only in the new fund are cashing out the previous investors, so this is much more of a concern. But they are new and still usually riding the feeling of wow, they let me invest in this awesome fund. PE firms are really good at creating an aura of exclusivity and luxury. A rolling loan gathers no loss. So long as the music keeps playing, valuations can be whatever number you can get your auditor to agree to. Nice dinners and event tickets for your audit partner can help with that.

_uy6i 4y ago
Except I think in the case where I’m an LP in both funds I potentially pay an incentive fee in Old fund even if the value defines dramatically in new fund, so still could be bad for me
- pevey 4y ago
  This is true, it cashes out the carried interest as well, so if the new fund closes with a lower valuation for that investment, the investor was screwed out of more carried interest than should have been paid.
collegeburner 4y ago
It's not a "right time" argument, I've seen people place these and they're usually pitched that this is a "real winner" and there's a bunch more growth left if they stay invested. That's why they're moving towards single-company funds. And sometimes they're right tbh. And tbh there would be some other LPs cashing out the previous investors if the company was sold normally. The only LPs who take this risk are the ones who buy into the new fund. And if they're worried they should just check the GP commit, if it's thin then obv they're just pulling fees so don't invest. Some of the continuation funds the GPs actually believe they have a really good investment and they increase their commit as a %. And the increasing valuations you describe are literally the same as the public markets the past few years. No bribing audit partners required.

miketery 4y ago

LPs are usually pension plans, endowments, or family offices. The stewards of these have different incentives than the ones that are tied to the capital.

yieldcrv 4y ago

LPs don't have a say. Their ability to withdraw/redemption is often heavily constricted too. (I’m not making an opinion on GP behavior yet)

collegeburner 4y ago
Uhh yeah they do. Maybe it's technically the GPs decision but I have watched GPs get their asses chewed by LPs and make a different call after those kinds of meetings. More importantly literally all LPs have to do is not invest in the continuation fund. It costs them 0 money extra to close out their position in the old fund and leave. Continuation funds are 100% optional. Also IMHO continuation funds can be useful if a PE firm thinks it has a real winner. It's harder than you think to find good places to place a lot of money so it will grow so I can understand why LPs might go for it in some cases.