W ith various headwinds resulting in down volume in 2023, buyers and sellers alike find themselves asking whether 2024 will see a rebound in deal activity. As we begin 2024, we have highlighted the issues and trends that private equity (PE) investors should consider when evaluating transactions in the healthcare sector. 1. Healthcare Continuation Funds: Strategic Considerations BY BRYAN BYLICA With a sluggish 2023 for platform exits, an increasing number of PE funds looked to continuation funds to offer liquidity to their limited partners (LPs). With the outlook for the first half of 2024 still uncertain, PE funds should continue to evaluate continuation funds as a viable option. A continuation fund is a general partner-led secondary transaction that is designed to offer LPs liquidity with respect to their interests in one or more mature portfolio companies within an existing PE fund. Continuation funds offer LPs in a PE fund the option to either cash out their investments before the underlying portfolio investments generate liquidity on their own or to retain their investment and “roll” into the continuation fund (and often make an additional incremental commitment to support the mature portfolio company(ies) in the continuation fund). Continuation funds are often formed to extend the life of a successful fund, enabling the fund manager to retain and manage mature, high-performing assets for an extended period rather than selling them prematurely. This strategy can be beneficial for both fund managers and investors, allowing for increased flexibility and potentially higher returns. It also offers the opportunity for institutional secondary investors to invest in high-performing portfolio investments managed by experienced sponsors. A typical continuation fund transaction will be led by a single institutional investor experienced in secondary transactions or a small group of experienced secondary investors that will negotiate the terms of the continuation fund transaction and the continuation fund structure. Continuation funds in the context of healthcare investments operate similarly to those in general PE. These funds are particularly relevant in the healthcare sector, where the development of innovative therapies and technologies may require longer investment horizons. The continuation fund model offers fund managers the flexibility to extend the life of a healthcare fund nearing the end of its term to allow high-performing portfolio companies the time they need to reach their full potential while providing additional capital to support the continued growth and development of these portfolio companies, while at the same time offering liquidity to LPs that wish to exit the investment.
Considerations when utilizing continuation funds include:
• Alignment. Ensure that the interests of the existing and new investors align in terms of investment horizon, risk appetite, and return expectations. New investors will also seek alignment with the general partner through the reinvestment of crystallized carried interest and often an investment of fresh capital. • Valuation and Pricing. Carefully assess the valuation of the portfolio investments being transferred to the continuation fund to ensure a fair and transparent pricing mechanism. The existing fund’s advisory board often plays a role in approving the valuation of the portfolio investments, given the inherent conflicts of interest in continuation fund transactions. • Transaction and Fund Structure. Design a continuation fund transaction and fund structure that is tax efficient for selling, rolling and new investors and accommodates the specific needs and preferences of both rolling and new investors. • Due Diligence. The lead investors will conduct thorough due diligence on the portfolio companies being transferred to the continuation fund to identify any potential risks, challenges, or opportunities that may impact the continued performance of these investments. Representation and warranty insurance is generally available for continuation fund transactions where the existing investors desire a “walk away” deal.
1 HEALTHCARE PRIVATE EQUITY: 2024 OUTLOOK & TRENDS IN M&A |
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