Venture capital funds typically have a defined lifetime, usually 10 years with the option to extend for an additional 1-2 years. But what happens when the fund's investments haven't fully exited by the end of the fund's lifetime? And what options do limited partners have if they need liquidity before the fund's investments have fully exited?
Fund managers have three primary mechanisms to address these scenarios: fund extensions, continuation funds, and secondaries. Understanding how each works and how to model them is important for fund managers planning for the end of their fund's lifecycle and for limited partners evaluating their investment options.
Fund extensions
A fund extension is a formal extension of the fund's lifetime beyond the original term specified in the limited partnership agreement (LPA). Extensions are typically used when the fund still holds investments that haven't exited, and the general partners (GPs) need more time to realize value from those investments.
When extensions happen
Fund extensions typically occur when the fund is approaching the end of its stated lifetime (typically 10 years) but still holds ownership in portfolio companies that are performing well but haven't reached an exit point. Market conditions might make it difficult to exit investments at reasonable valuations, or the fund may need additional time to work with portfolio companies to create exit opportunities.
Most LPAs include provisions for fund extensions, typically requiring approval from a majority of limited partners (often 50-75% by committed capital) and sometimes requiring a vote of the advisory committee or board.
Modeling extensions
When modeling a fund extension, you'll need to consider several factors. The extension period is typically 1-2 years, though some LPAs allow for multiple extensions. The extension period should be long enough to allow for meaningful progress on exits, but not so long that it becomes a de facto permanent fund.
Most LPAs specify that management fees are not charged during extension periods, though some may allow for reduced fees (e.g., 1% instead of 2%) to cover basic operational expenses. This is an important consideration for budgeting the management company. The fund will still incur operational expenses during the extension period - fund administration, audit, tax, legal - which will reduce the capital available for distributions to LPs.
During the extension period, the GP's focus shifts from making new investments to managing existing portfolio companies toward exits. This may involve more active work with portfolio companies, potential bridge financing, or strategic positioning for exits.
In your fund model, you can add an extension period by extending the forecast timeline beyond the original fund lifetime, setting management fees to zero (or reduced rate) for the extension period, continuing to model operational expenses, modeling potential exits and write-offs during the extension period, and updating performance metrics (IRR, TVPI, DPI, RVPI) to reflect the extended timeline.
The Venture Capital Model is prebuilt for 20 years, and by default the model automatically adds fund extension periods if the portfolio construction approach and timing of exits creates exits in years outside of the fund lifetime.
Continuation funds
Instead of extending the existing fund, a fund manager may choose to create a continuation fund - a new fund vehicle that acquires the remaining portfolio companies from the original fund. This allows the original fund to close out cleanly while giving the portfolio companies more time to reach exit, all within a new fund structure.
When to use continuation funds vs. extensions
Continuation funds are an alternative to fund extensions, and the choice between them depends on several factors. You might choose a continuation fund when the fund wants to close out the original fund cleanly rather than extend it, when there's demand from new LPs to invest in the remaining portfolio, when the GP wants to reset fund economics (management fees, carried interest) for the remaining assets, when the portfolio is strong enough to attract new capital at attractive valuations, or when LPs want optionality - some may roll into the continuation fund, others may take cash.
On the other hand, you might choose a fund extension when the fund just needs a short additional period (1-2 years) to complete exits, when the portfolio doesn't warrant creating a new fund structure, when LPs prefer to keep everything in the original fund, or when the administrative complexity of a continuation fund is not justified.
How continuation funds work
A continuation fund transaction typically works as follows. First, the GP selects which portfolio companies to transfer to the continuation fund, often the best-performing companies that need more time. The portfolio is then valued, typically by an independent third party, to establish a fair market value (FMV) for the assets. A new fund is created with new LPs (or existing LPs who choose to roll) who invest capital to purchase the portfolio assets. In recent years, continuation funds have gained significant traction - in 2024, continuation vehicles accounted for approximately 85% of GP-led secondary transaction volume.
Existing LPs in the original fund typically have three options. They can roll over by transferring their interest into the continuation fund to maintain exposure. They can cash out by taking cash at the transaction price, realizing returns now, though potentially at a discount to eventual exit value. Or they can remain in the original fund with remaining assets, if any assets aren't transferred.
The selected portfolio companies are then transferred from the original fund to the continuation fund at the established FMV. The continuation fund has its own economics: new management fees (typically 2% on invested capital or AUM), new carried interest (typically 20%), a new fund lifetime (typically 5-10 years), and a new operational structure.
Modeling continuation funds
Modeling a continuation fund requires modeling both the original fund and the new continuation fund. For the original fund model, you'll model the fund through the continuation fund transaction date, calculate the value of assets being transferred to the continuation fund, model the transaction (assets transferred at FMV, cash proceeds to LPs who cash out, and any remaining assets that stay in the original fund), and close out the original fund or model remaining assets if some stay.
For the continuation fund model, you'll model the new fund structure including fund size (the capital raised to purchase assets), management fees (either on invested capital or assets under management), carried interest structure, and fund lifetime. You'll model the acquired portfolio including starting value (the fair market value at acquisition), expected exits over the continuation fund's lifetime, and expected returns to continuation fund LPs. Finally, you'll model LP economics: for LPs who rolled, show their economics in the continuation fund; for LPs who cashed out, show their final returns from the original fund.
The FMV used for the transaction is critical - it determines the price for LPs who cash out and the starting value for the continuation fund. Continuation funds are typically priced at or near NAV (unlike secondaries which are often at a discount), as the GP is facilitating the transaction. You'll want to model the economics for each LP option (roll over, cash out, remain) to help LPs make decisions. The GP may earn new management fees and carried interest in the continuation fund, which impacts management company budgeting. Continuation fund transactions typically take 6-12 months to complete, including due diligence, fund formation, and LP decisions.
Advantages and disadvantages of continuation funds
Continuation funds offer advantages for both GPs and LPs. For GPs, they provide clean closure of the original fund, new management fees and carried interest on the continuation fund, the ability to bring in new LPs who want exposure to the portfolio, and more time to realize value from strong portfolio companies. For LPs, they provide optionality - the ability to roll, cash out, or remain, liquidity options for LPs who need it, the ability to maintain exposure to strong portfolio companies if rolling, and a fresh fund structure with new economics.
However, continuation funds also have disadvantages. They're more complex than extensions - requiring fund formation, valuation, LP decisions, and asset transfer. They have higher transaction costs (legal, valuation, fund formation) compared to extensions. They take longer to execute (6-12 months) compared to extensions, which can be done more quickly. They require coordinating with LPs on their decisions (roll, cash out, remain). And there's valuation risk: if the FMV is set too high, continuation fund LPs may overpay; if too low, original fund LPs who cash out may leave money on the table.
Example: modeling a continuation fund
Consider a concrete example: a $50M fund that's 10 years old with 5 remaining portfolio companies and a combined NAV of $75M (1.5x on invested capital). A continuation fund transaction establishes FMV at $75M, and the new fund raises $75M to purchase assets. LPs have options: 60% roll, 30% cash out, 10% remain. For the original fund, you'd transfer $75M of assets to the continuation fund, distribute $22.5M cash to LPs who cash out (30% × $75M), and the remaining LPs (60% roll, 10% remain) would have interests in the continuation fund or remaining assets. The continuation fund would start with $75M in assets, have a 5-year lifetime, charge 2% management fees with 20% carry, and you'd model exits over 5 years with returns to continuation fund LPs.
Secondaries
A secondary transaction occurs when a limited partner sells their interest in the fund to another party before the fund has fully exited its investments. Secondaries provide liquidity to LPs who need to exit their investment early, while allowing the fund to continue operating normally.
Types of secondary transactions
There are several types of secondary transactions. LP-to-LP secondaries occur when one limited partner sells their interest to another limited partner or a new investor. This is the most common type of secondary transaction and typically requires GP consent.
GP-led secondaries occur when the general partner initiates a transaction to provide liquidity to LPs, often by creating a new fund vehicle to acquire the assets from the existing fund. This can be structured as a continuation fund, a tender offer where LPs can choose to roll their interests into the new fund or take cash, or a strip sale where a portion of the portfolio is sold to a new fund.
Direct secondaries occur when an investor purchases direct interests in specific portfolio companies rather than fund interests. This is less common but can occur when an LP wants exposure to specific companies.
Modeling secondaries
Modeling secondaries in a fund model can be complex because they represent a change in ownership structure rather than a change in the fund's operations. For LP-to-LP secondaries, these transactions don't typically impact the fund model itself, as the fund continues operating normally. However, you may want to track the percentage of the fund that has been sold, the pricing of secondary transactions (often at a discount to NAV), and the impact on remaining LPs' ownership percentages.
Foresight's venture models are prebuilt to handle secondaries in a couple different ways, depending on the portfolio construction method. Details at Secondaries.
For GP-led secondaries, these transactions can significantly impact the fund model. You'll need to model the transfer of portfolio companies from the original fund to the continuation fund, price the secondary transaction (typically at a discount to net asset value, often 10-30% depending on the quality of the portfolio and market conditions), model the choice LPs have to either take cash at the secondary price, roll their interest into the continuation fund, or remain in the original fund if allowed, and if creating a continuation fund, model the new fund's economics including management fees, carried interest, and expected returns.
Secondary buyers will conduct due diligence on the portfolio and will price based on their assessment of the portfolio's value, not the fund's reported NAV. Secondary transactions can take 3-6 months to complete, including due diligence, negotiation, and legal documentation. GP-led secondaries can create new economics for the GP, including new management fees and carried interest in the continuation fund. Secondary transactions can have tax implications for both sellers and buyers, and the structure of the transaction matters.
Secondary pricing
Secondary transactions are typically priced based on net asset value (NAV), which is the current reported value of the fund's investments. Secondary buyers typically require a discount, reflecting an illiquidity premium (the buyer is taking on the risk of future exits), portfolio quality (stronger portfolios command smaller discounts), market conditions (tighter markets mean smaller discounts), and time to exit (longer expected hold periods mean larger discounts). This discount typically ranges from 10-30%, depending on these factors.
Choosing between extensions, continuation funds, and secondaries
Fund managers have three primary options when a fund approaches its end with remaining portfolio companies. They can extend the original fund's lifetime, which is simplest but provides limited time. They can create a new fund to acquire remaining assets, which is more complex but provides fresh structure and LP optionality. Or they can provide liquidity to LPs through a secondary sale, which provides liquidity but may be at a discount.
The choice depends on several factors. Strong portfolios may warrant continuation funds or attract secondary buyers. If LPs need liquidity, secondaries or continuation funds with cash-out options may be preferred. Short extensions (1-2 years) may favor extensions; longer periods may favor continuation funds. GPs may prefer continuation funds to reset economics and bring in new LPs.
Combining strategies
Fund managers may use multiple strategies. They might extend first, then create a continuation fund if more time is needed. They might extend the fund but offer secondary liquidity to LPs who need it. Or they might create a continuation fund where some LPs roll and others take cash (secondary).
Modeling combined strategies requires extending the fund timeline if using an extension, modeling the continuation fund or secondary transaction, showing the economics to LPs under each option, and comparing scenarios to help LPs make decisions.
Performance metrics impact
Extensions, continuation funds, and secondaries all impact key performance metrics differently. Extensions typically reduce internal rate of return (IRR) because they extend the time period over which returns are calculated, even if the total return multiple remains the same. Continuation funds reset the clock - LPs who roll start fresh in the new fund, while LPs who cash out realize their IRR at the transaction date. Secondaries can impact IRR depending on the pricing and timing.
For DPI (distributed to paid-in capital), extensions delay DPI as distributions are pushed further into the future. Continuation funds accelerate DPI for LPs who cash out (at FMV), while LPs who roll maintain their exposure. Secondaries can accelerate DPI if LPs take cash, but at a discount to eventual exit value.
For RVPI (residual value to paid-in capital), extensions maintain RVPI as investments remain in the portfolio. Continuation funds convert RVPI to DPI for LPs who cash out (at FMV), while LPs who roll transfer their RVPI to the continuation fund. Secondaries reduce RVPI for LPs who exit, but the pricing reflects the discount to NAV.
For TVPI (total value to paid-in capital), extensions maintain TVPI (DPI + RVPI) but delay the conversion of RVPI to DPI. Continuation funds maintain TVPI for LPs who roll (transferred to continuation fund), while LPs who cash out realize TVPI at the transaction date. Secondaries convert RVPI to DPI at a discount, potentially reducing TVPI for exiting LPs.
Best practices
When modeling extensions and secondaries, model different scenarios throughout the fund's life, and keep LPs informed about the fund's progress and potential need for extensions or secondary options. Create scenarios for no extension with all exits by year 10, a 1-year extension with partial exits, a 2-year extension with full exits, a continuation fund transaction, secondary transactions at various points, and combined strategies like an extension then a continuation fund.
Understanding your LP base helps in planning for secondaries. Clearly document your assumptions about exit timing, continuation fund valuations, secondary pricing, and extension periods in your model. Model all three options (extension, continuation fund, secondary) to help make the best decision for your fund and LPs.
Questions on modeling fund extensions, continuation funds, and secondaries, ask anytime.