Conflicts of Interest in Continuation Funds

This report is the second of a three-part series on ethics in private markets. The first report, Continuation Funds: Ethics in Private Markets, Part I, explains what continuation funds are and concisely summarizes the key ethical issues they raise. Continuation funds are also called continuation vehicles (CVs), and we use both terms interchangeably.

In efficient capital markets, prices are determined by arm’s-length transactions between buyers and sellers. But what happens when the buyer is the seller? That is the question posed by continuation funds, where the general partner sits on both sides of the same transaction. This dual role is not unprecedented — management buyouts offer another example — but it raises heightened conflict-of-interest and ethical questions.

The GP serves as the agent for the sellers (the LPs who cash out) and will become the agent for the buyers (incoming investors) once the CV is established. The GP owns an equity stake in the legacy fund and will take an equity stake — often a larger one — in the CV. The GP has strong financial incentives yet plays a key role in determining the CV transaction price. That role includes leading a competitive bidding process, selecting a lead investor, and negotiating the transaction terms. Finally, the GP continues to serve as manager of the legacy fund and will also manage the continuation fund.

This report explores the major conflicts of interest and identifies actions that would be unethical if undertaken. It also describes best practices that have evolved to manage these conflicts. Our purpose is neither to denigrate nor to defend CVs but, instead, to offer an even-handed and fair explanation of the ethical issues involved. A primary goal is to raise practitioners' awareness and help them navigate conflicts and act ethically. Another goal is to inform regulators, the media, and other interested parties.

To ensure continuation fund transactions create value without leaving any party worse off, market participants should follow these core recommendations:

For General Partners (GPs)

• Establish a Sound Investment Rationale: Clearly define and communicate the economic and operational basis for forming a CV to legacy LPs.
• Drive Competitive Bidding: Conduct a vigorous, transparent bidding process with independent third parties to establish fair transaction pricing.
• Offer a True Status Quo Option: Provide rolling LPs the ability to maintain their investment on economic terms equivalent to the legacy fund, without forced fee increases or reset hurdles.
• Ensure Information Parity: Deliver identical, timely disclosures to both buying and selling counterparties, providing equal access to data room materials.
• Independent Valuation Oversight: Obtain an independent fairness or valuation opinion on a comply-or-explain basis. If an opinion is omitted, formally explain the rationale to the limited partner advisory committee (LPAC) and disclose key valuation assumptions if an opinion is rendered.
• Avoid Stapled Transactions: Eliminate conditionality requiring incoming CV investors to commit capital to separate GP-affiliated funds, preventing distorted price negotiations.

For Limited Partners (LPs)

• Verify Price Discovery Rigor: Insist on evidence of arm's-length third-party bidding.
• Audit Valuation Continuity: Inspect changes in valuation methodologies between standard fund reporting and continuation fund marketing materials.
• LPAC Recusal Protocols: LPAC members who are participating as investors in the new CV should abstain from voting on conflict-of-interest waivers.
• Recognize Governance Limits: Acknowledge that LPAC members generally do not owe fiduciary duties to non-LPAC limited partners unless explicitly required by the limited partnership agreement (LPA).

For Regulators

• Target Conflict Supervision: Focus oversight on compliance with LPA terms, anti-fraud enforcement, valuation consistency, and financial reporting standards.
• Construct Retail Guardrails: Utilize governance lessons from institutional CV conflicts to design structural protections before expanding retail access to private-market funds.

The CV transaction price is the outcome that matters most for all the CV participants. It is the litmus test that determines the fairness of the CV transaction. But how do we judge the fairness of the transaction price?

Incoming investors in the CV face the risk of adverse selection. Selling LPs, in contrast, face the risk of inadequate consideration for their interests. Price discovery in CV transactions is neither objective nor fully independent.

Public markets offer price discovery that is continuous, observable, and objective. Private funds, in contrast, hold illiquid assets where the market price comes into view only in an eventual traditional exit.

Unlike a traditional exit, however, the CV allows the GP to retain control (and some equity) even after the transaction. Because intrinsic asset projections introduce subjectivity, the procedure becomes especially important. We judge the fairness of a CV transaction by how rigorously the process approximates independent, competitive market standards.

To anchor the analysis that follows, it is useful to distinguish three related but conceptually distinct phenomena: structural conflicts of interest, procedural failures, and intentional misconduct.

• Structural Conflicts of Interest: Inherent economic frictions arise because the GP sits on both sides of the transaction. Conflicts are unavoidable, but their existence alone is not inherently unethical if properly mitigated and disclosed.
• Procedural Failures: Breakdowns in governance, compressed decision timelines, inadequate disclosures, or failure to offer a status quo option.
• Intentional Misconduct: Unambiguously unethical actions that exploit structural conflicts to transfer value from legacy LPs to the GP or favored investors (e.g., hiding IPO plans, manipulating valuation inputs, selective disclosures).

These distinctions are particularly relevant in settings where a single actor influences both sides of a transaction, raising concerns about self-dealing and the potential transfer of value across investor groups. This framework underpins the analysis in this report.

Practitioners and LPAC members should monitor transaction processes for key operational red flags:

• Competitive and Independent Bidding: Ensure price discovery is anchored by a vigorous, arm's-length bidding process directed by a third-party lead investor.
• LPAC Oversight and Group Engagement: Engage the LPAC as a unified body early in the process, granting in camera sessions and respecting vote abstentions for conflicted members.
• Independent Valuation and Fairness Opinions: Benchmark GP assumptions against third-party valuation opinions when observable market prices do not exist.
• Complete and Timely Disclosures: Provide legacy LPs with a minimum of 30 calendar days (or 20 business days) alongside full data room transparency to evaluate roll-or-sell choices.

Section I focuses on structural conflicts of interest in CVs. The GP has key financial incentives that can raise conflicts of interest with the LPs. Though media and practitioner attention have focused on potential misalignments between the GP and LPs, competing interests can also arise among LPs themselves, as we will discuss.

Section II examines the processes for managing conflicts of interest when forming a CV. The section emphasizes the real-world complexities of CVs, in which investors can have competing interests, differing perspectives, and disparate outcomes.

Section III examines actions that would be unambiguously unethical if undertaken by a GP. These actions often result in squeezing out legacy LPs and appropriating their profits.

Section IV describes best practices and procedures designed to enable the GP to manage conflicts of interest fairly and ethically. We base our judgments on several pillars, including industry best practices, the CFA Institute Code of Ethics and Standards of Professional Conduct, and the CFA Institute Asset Manager Code™.

The Conclusion elaborates on four key elements — price, other economic terms, process, and disclosures — that collectively represent hallmarks of a fair process. Practitioners can use these elements as guardrails as they seek to engage in ethical conduct and to address inherent conflicts of interest in forming a CV.

Appendix 1 situates the report’s framework within relevant strands of economic, legal, and ethical scholarship. We present this framework in an appendix to preserve readability in the main body of the report for practitioners and other nonacademic readers.

Appendix 2 describes our research methodology.

• Conflicts of interest are unavoidable in continuation funds because the GP sits on both sides of the transaction. Ethics depend on whether conflicts are adequately mitigated and disclosed.
• Transaction price is the financial outcome that matters most, but process integrity must validate price fairness.
• Offering rolling LPs a true status quo option is essential for fair treatment under the GP's duty of loyalty.
• Disclosures must be materially complete, accurate, and timely to enable informed LP consent.