Understanding Continuation Funds: A Growing Trend


What Are Continuation Funds?

Continuation funds have emerged as a vital strategy for fund managers, offering advantages such as the ability to retain interests in high-performing assets while providing liquidity to current investors. In general, they serve two main purposes: they help de-risk the sales process while providing Limited Partners (LPs) with liquidity, especially useful in tough market conditions. Additionally, they enable General Partners (GPs) to retain and manage assets they believe have further growth potential.

These funds can be structured as single-asset or multi-asset continuation funds. Single-asset funds focus on one specific asset, allowing managers to concentrate their efforts, while multi-asset funds offer diversification and risk spreading.

As their popularity continues to grow, it is essential for fund managers to understand the tax and reporting obligations associated with establishing such funds. This article highlights key tax considerations that should be taken into account when setting up a continuation fund - it is imperative to seek advice to fully understand the associated tax and reporting obligations.
 

Setting up a continuation fund

The process typically begins with the fund manager of the original fund creating a new fund, known as the continuation fund. A series of transaction steps would be implemented where a specific investment (or group of investments) in the original fund will be transferred to the continuation fund. Investors in the continuation fund typically include a mix of investors from the original fund who wish to maintain their investment in these assets and new investors. For investors who prefer not to maintain their investment, a cash exit option is typically available. For management, there may be crystallisation of existing management incentive arrangements on the transfer of the investment to the continuation fund or a rollover requirement.

While there are various ways to structure a continuation fund, each approach should be tailored to the specific circumstances. Despite being managed by the same team as the original fund, the continuation fund operates under its own set of terms and economic conditions. This allows both the fund manager and investors to renegotiate aspects like management fees, carried interest, co-investment, management equity plan etc.
 

Continuation funds - key tax considerations

Where the continuation fund should be set up largely depends on the jurisdiction of the investors, their preferences, legal and regulatory considerations, the set-up and running costs amongst other considerations.

On setting up the new structure, it is also a good opportunity to review the existing fund structure to see whether there are opportunities to improve operational efficiency and to understand the associated tax and reported implications such as VAT grouping and VAT recoverability on management fees. In practice, the continuing investors may want to see a consistent structure to the original fund in order to simplify their due diligence.

With the introduction of new fund entities and removal of old fund entities, there will be changes in reporting obligations for private equity houses and executives.

Exiting investors

For exiting investors, there are likely to be tax and reporting implications depending on their tax status, jurisdiction of tax residence, how they have funded the investment i.e. equity / debt, and continuation fund transaction steps.

Continuing investors and co-investors

For continuing investors, review should be undertaken on whether they can roll their investment over into the continuation fund in a tax-neutral way – this is often possible but requires consideration, and HMRC clearance may also be considered and factored into timeframes.

For private equity executives who are co-investors into the new structure, it is important to consider any potential tax liabilities on rolling into the new fund. The funding of any tax liabilities should be taken into account when negotiating the terms of the team’s investment with investors.

There are a number of options to consider when funding co-investment for example personal funding, loans from the fund manager, other debt such as mezzanine or by way of management fee waiver (more popular in US funds) – different tax implications apply depending on which funding option is chosen.

New investors

For new investors in the continuation funds, they may want to understand the tax implications such as stamp duty considerations of making the investment and the expected tax implications on realisation of returns.

There may also be international considerations for example blockers considered for specific types of US investors and German investor reporting.

Carried interest holders

Where carried interest is realised on the continuation fund transaction, then there will be tax implications - even if the carry is reinvested into the new structure and cash is not actually received. From 6 April 2026, all carried interest is treated as trading income taxed at a lower rate of 34.075% only if the carried interest is qualifying – carried interest is qualifying only if the average holding period conditions are met. Read more about carried interest tax reform and how it works.

New carried interest terms will be typically considered for fund executives of the continuation fund. It is important to ensure that the new arrangements meet the conditions to be taxed as carried interest. There are tax and reporting considerations when awarding carried interest that should not be overlooked. Furthermore, the holding period expected in the new vehicle should be considered, as this may impact whether the new carried interest will be qualifying or non-qualifying.

Management

On the continuation fund transaction, under an existing management incentive plan, returns may be crystallised for management. It is important to understand the tax implications of these such as whether treated as income or capital depending on how returns are repatriated.

New management incentive plan terms will be typically considered for management. Understanding the tax implications on award of incentives and realisation of returns are important.

Investment

It is important to consider the expected nature of the later exit by the continuation fund and ensure that the holding structure is appropriate.

Given the various tax advantages of the qualifying asset holding company regime, it is also a good time to consider whether the eligibility requirements are met to enter this regime and the associated tax and reporting implications. Read more about the practical considerations of QAHCs.

Challenges and Conflicts

Continuation funds can present conflicts of interest, primarily due to asset transfers between funds managed by the same team. Key areas of conflict include:

  • Valuation Disputes: The valuation of assets being transferred can be contentious. The original fund may want a higher valuation to maximise returns, while the continuation fund might prefer a lower valuation to ensure future gains.
  • Fee Structures: Different fee structures between the original and continuation funds can lead to conflicts. The management team might be incentivised to favour one fund over the other based on fee arrangements.
  • Investor Interests: Existing investors in the original fund might have different interests compared to new investors in the continuation fund. Balancing these interests can be challenging, especially if the management team has stakes in both funds.
  • Decision-Making Bias: The management team might face pressure to make decisions that benefit one fund over the other, particularly if they have personal investments or bonuses tied to performance.
  • Transparency Issues: Ensuring clear communication and transparency between all parties involved is crucial. Lack of transparency can lead to mistrust and perceived conflicts of interest.

Addressing these conflicts requires careful management, clear communication, and often third-party oversight to ensure fairness and transparency for all investors involved.

BDO Valuations are able to provide independent valuation services for funds looking to address these issues.


Next steps for finance and tax teams

Before setting up a continuation fund, finance and tax teams should:

  • Understand the tax and reporting implications of the steps required to implement the continuation fund transaction such as stamp duty and withholding tax considerations, considerations for the exiting and continuing investors, fund executives who hold carried interest entitlements or co-investment and management
  • Review what the continuation fund structure should look like considering commercial and tax objectives, and understanding the tax and reporting implications for the fund entities, investors and fund executives, including VAT and any transfer pricing where relevant
  • Review what the incentive arrangements should look like for example carried interest and management equity plans, and understanding the tax and reporting implications in relation to these
  • Ensure ongoing operational tax and reporting obligations are met.


If you are considering a continuation fund transaction, we can help you understand the tax, reporting and structuring implications for the fund, its investors and management team. If you would like to discuss the above in relation to your structures, please feel free to get in touch with Jennifer Wall, Matthew Glover or Nicoletta Papademetris.