Perhaps even more dazzling than the setting at the Monarch Beach Resort & Club was Clearlake’s recent performance, which had blown through almost every imaginable benchmark, with one fund generating average annual returns of 50%.
One reason for the firm’s success, according to one attendee and documents shared at the gathering: Clearlake was selling the companies it owned from one set of investment funds to another set of funds it also managed called “continuation vehicles.”
Continuation funds are meant as a temporary fix for a serious problem that has been bedeviling firms like Clearlake.
Private equity firms have been struggling to deliver on their core business model of taking on debt, buying companies and selling them for a profit. Several years of high interest rates have made it too expensive for many would-be buyers to purchase companies with debt, and private equity firms are contending with a backlog of more than 31,000 unsold companies, a record amount. Deal activity picked up toward the end of this year, but not enough to make a significant dent in the backlog.
Continuation vehicles are providing a short-term solution by allowing firms to sell the companies to themselves, book a paper gain and wait for interest rates to improve.
Private equity firms have been turning to this strategy more frequently. The dollar value of continuation vehicles across the industry is expected to total $100 billion or more by the end of 2025, up from about $35 billion in 2019, according to the investment bank Evercore. Private equity is one of the biggest parts of the global economy, with more than $7 trillion in investors’ money, and some of those investors are getting increasingly worried that strategies like continuation vehicles are putting off a painful reckoning. Private equity firms say they are selling only their best-performing companies to continuation vehicles, which would yield big profits when the companies can eventually be sold to outside buyers.
The risk, investors say, is that the insular nature of these sales – where the private equity firm is both the buyer and seller – is leading to questionable valuations and unrealistic projections, leaving investors vulnerable to painful surprises.
At the gathering of pension managers and other Clearlake clients at the Monarch Hotel in 2022, the firm boasted about the success of Wheel Pros, an auto accessories retailer that it had sold to one of its continuation funds.
The company sells flashy hubcaps and other accessories for wheels, which were popular during the pandemic when consumers were flush with stimulus money and had time for do-it-yourself projects.
Two years after that gathering, in September 2024, Wheel Pros declared bankruptcy, because sales slowed after the pandemic. The company couldn’t keep up with its ballooning debt payments. Every investor, including public employees’ pension funds from New York, Connecticut and Nevada, was wiped out. (Connecticut and Nevada had previously sold out of some of their Wheel Pros stake.)
Clearlake Capital declined to make their executives available for an interview. In a 2023 podcast interview, Jose E. Feliciano, a founder of the firm, said it used continuation vehicles for “companies that were A-plus assets that we wouldn’t mind owning for a long time, maybe forever.” He added that it was also for companies that would need more time and investment to realise their full potential.
Platinum Equity, another firm, has struggled with its investment in United Site Services, which makes portable toilets. In 2021, Platinum Equity executives described the sale of United Site Services to a continuation fund it created as a “win-win.” Now, United Site Services is in the process of turning the company over to its lenders, and its investors are expected to lose all their money. “Continuation vehicles are indicative of rot in private equity,” said Marcus Frampton, chief investment officer of the Alaska Permanent Fund Corporation, which manages $83 billion of the state’s money that is derived from oil revenues and distributed annually to Alaskans.
The increased use of these funds, he said, is one of the reasons the Alaska fund has scaled back investments with private equity firms. Frampton said the firms were shirking their purpose to create value through buying and selling companies. In 2021, the Alaska fund held 22% of its dollars in private equity firms. Now it holds about 17%.
Scott Ramsower, who oversees the private equity investments of the Teacher Retirement System of Texas, a pension fund that manages roughly $229 billion, said there were inherent conflicts in continuation funds because a private equity firm is typically involved on both sides of the deal.
“We’d be happier if a private equity firm never did any of these,” Ramsower said about continuation funds.
The private equity industry says there are no conflicts because the deals are independently vetted. First, a private equity firm’s largest investors must consent to selling a portfolio company to a continuation vehicle. Then, existing and new investors have a chance to scrutinise the company’s financials and decide whether to buy into a deal at a specific price tag. If the investors don’t see the upside for future returns for a specific company when it is finally sold to an outside buyer, the deal won’t move forward.
But some investors say this vetting process is not always transparent.
This month, Abu Dhabi’s sovereign wealth fund filed a lawsuit in the Delaware Court of Chancery claiming that Energy & Minerals Group, a private equity firm, was seeking to “reap a massive benefit for themselves” at the expense of their investors by selling a company into a continuation vehicle.
According to the lawsuit, the firm tried to force the sovereign wealth funds and other investors to vote on the sale on short notice, provided different data to different investors and would not allow the investors to confer with each other about the deal.
Energy & Minerals Group did not respond to requests for comment.
Nigel Dawn, global head of private capital advisory at Evercore, said that so far continuation fund bankruptcies were below the rates of traditional buyout funds, which hover between 5% and 10%.