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11.24.21

Venture capital and private equity investors seek to balance risk and opportunity

By , Richard L. Shamos

Richard Shamos and I recently discussed what’s new as venture capital and private equity investors seek to balance risk and opportunity, with a focus on continuation fund transactions in a highly dynamic, ever-evolving market. We are seeing an increasing trend within the venture capital/private equity spaces in the use of continuation funds to manage the life cycle of companies and their investors.

Watch a video of our conversation as we take a deeper dive into these key takeaways:

  • A continuation fund transaction occurs where a fund that holds a particular asset, generally private equity in a company, sells that asset to an affiliated fund. These situations can arise in a variety of contexts, but typically they are closely related to the life cycle of the relevant investment fund and the life cycle of the target company
  • Venture capital investors tend to prefer to invest over a long period of time in early stage companies. Compared to other types of investors, they are more willing to embrace a variety of forms of risk. This includes the specific risk that an investment will completely fail
  • As the life cycle of a company changes over its initial investors’ holding period, there arises a mismatch between the company’s future strategic plans and the investors’ core strategy. While this life cycle stage may not correlate with the original investors’ core expertise, it may align well with other new investors’ target objectives and strategies, creating an exit opportunity
  • However, at this juncture we often encounter funds electing to not sell an asset outright, often because private equity and venture capital investors bring specific expertise to the industries in which they invest, so new investors may wish for an existing manager to remain involved
  • A continuation fund also provides flexibility to existing investors with more flexible risk profiles, who may elect to roll their interest in the selling fund into the new vehicle
  • Continuation fund transactions require careful negotiation with counsel, as the transfer of assets between affiliated vehicles involves conflicts of interest and statutory requirements, which must be carefully managed between owners, investors, and managers
  • As a result, the key documentation involved in a continuation fund transaction includes consent documentation facing existing investors, the continuation fund’s offering and subscription documentation, and a purchase agreement generally negotiated with one or more lead investors
  • In addition, taxation can be a big issue when rolling over old investors into the new vehicle, which requires careful consideration and the potential to conduct a tax-free exchange
  • Timelines of transaction can vary depending on the complexity of the fund mechanics and documentation, but take anywhere from one to three months

As investors balance risk, management, and exit opportunities, continuation fund transactions are likely to remain a powerful tool for managers to balance investor appetites with fiduciary responsibilities. With experience in both private transactions and investment fund structures, Nixon Peabody is here to help you navigate these complex transactions.

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Author

John Eden

Associate

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Author

Richard L. Shamos

Counsel

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