Continuation Vehicles from the LP Seat – Scott Ramsower (EP.523)

Scott Ramsower · Teacher Retirement System of Texas

CVs have conflicted pricing: the GP sits on both sides, so price and competitive process are hard to verify.

The GP acts as agent for the selling legacy LPs and, functionally, for the incoming CV investors. That dual role makes it hard for LPs to know whether the price is real or whether a competitive process was run. Scott calls this the main and original LP concern about CVs. The best-practice response he describes is requesting full bid transparency (for example, a higher bidder who pays 90 cents versus a lower bidder who pays 89 cents but commits to the GP's next fund) and treating third-party fairness opinions as only a limited check.

“The GP sits on both sides of the trade. They act as the agent for the seller, which is the legacy LPs. Functionally, they also act as the agent for the buyer, which is the incoming CV investors. That makes it hard to know whether the price is real, whether a competitive process was run.”at 11:58

Scott Ramsower · Teacher Retirement System of Texas

Every hour a GP spends on a CV is an hour not spent on the commingled fund LPs committed to.

CVs dilute the GP's mind share. Time spent on a CV is time not spent on the commingled fund that LPs committed capital to, and this matters even for LPs who do not invest in the CV. Scott also argues that a CV creates a new revenue stream of management fees and carry that lets the GP win even when the original fund loses, which breaks the goal of perfect alignment where LPs win only when the GP wins.

“Every hour a GP spends managing a CV is an hour they're not spending managing my commingled fund, the fund to which I committed capital. I may be an investor in that CV, but if I'm not, I'm losing their mind share.”at 15:42

Scott Ramsower · Teacher Retirement System of Texas

Rolling into a CV can raise LPs' fees and carry on the same asset, a worse economic deal.

A headline management fee cut does not mean lower cost. Scott's worked example: a GP bought an asset at $100 and sells it to the CV at $300. The LP who rolls now pays a 70 basis point fee on a $300 cost basis, which is more than the 100 basis points on $100 the LP was paying in the original fund. Tiered carry can also leave carry above what the original fund charged. Scott says the GP should bear the burden of ensuring rolling LPs are economically no worse off, which he calls an economic status quo.

“The GP maybe bought the asset originally at a $100. They're gonna sell it to the CV at $300. Your new cost basis is $300, but LP is now paying 70 basis points on $300, which is higher than a 100 basis points of $100.”at 17:54

Scott Ramsower · Teacher Retirement System of Texas

LPs often cannot truly choose to roll a CV; short election windows and approvals force selling.

CVs are presented as an LP choice to roll or sell, but many LPs cannot act on it. Board approval processes can take longer than the CV window, legal teams may lack bandwidth for review, and election windows are often only 20 to 30 business days. Other priorities can also crowd it out. Because of this, many LPs' only real option is to sell, which Scott finds concerning.

“A lot of LPs for a variety of reasons don't have that choice. They may have a board approval process that takes longer than the CV process allows for. ... The election windows oftentimes can be short twenty to thirty business days.”at 18:35

Scott Ramsower · Teacher Retirement System of Texas

CVs lock in DPI and IRR for the original fund before value creation ends, flattering the GP's track record.

When the commingled fund sells an asset to a CV, it produces DPI and IRR for that fund, even though the GP is still managing the asset and the true value creation is not finished. This makes the GP's track record look better as a result of a conflicted transaction. Scott notes that LPs present these higher DPIs to their investment committees, and his team strips out this synthetic DPI from CVs and NAV loans when evaluating managers.

“Even though the asset is ongoing and the GP is still managing it, it has locked in DPI and IRR for the fund even though the true value creation is not yet done. As a result, the GP's track record arguably is improved through this conflicted transaction.”at 19:25

Scott Ramsower · Teacher Retirement System of Texas

A CV track record cannot win at investment committee: too good looks underpriced, too bad looks like poor judgment.

Texas Teachers shows the full track record, including CVs, to its investment committee. A strong CV record makes the committee suspect the GP sold too cheaply and that a fair process was not run. A weak CV record makes the committee question the GP's investment judgment in continuing to hold the asset. Scott says this leaves CVs structurally unable to outperform by much or underperform by much, a healthy tension he sees in the limited data, which is still early.

“it's almost a no win when we show the CV track record. If you walk in with a CV track record that's too good, you would think they'd be excited because it is still an investment judgment. And our investment committee is upset because they think if it did that well, they sold it for too cheap.”at 20:34

Scott Ramsower · Teacher Retirement System of Texas

CVs let GPs drop the exit decision and hand it to LPs, while LPs still pay two-and-twenty.

LPs pay a GP roughly two and twenty for three judgments: sourcing and evaluating investments, creating value in them, and exiting them. If a GP CVs every asset, it gives up the exit judgment as a conflicted party and leaves the decision to the LP, while LPs are not paying any less for taking the decision back in-house. Scott says the fee rate should be renegotiated, but acknowledges this is idealistic. The infrastructure around the two-and-twenty model makes change slow, so he presents it as a point to raise with GPs rather than a near-term outcome.

“If you take CVs to their logical extreme and a GP CVs every asset in its fund, it's thrown its hands up on the third and said, I'm conflicted. I can no longer make the exit determination. LP, it's your decision. That's fine, but I paid [a] GP to do three things. You're only doing two of those.”at 22:24

Scott Ramsower · Teacher Retirement System of Texas

CVs cannibalize fee-free co-investment, pushing deals into fee-paying vehicles that LPs must roll into.

Historically, a sale to another GP would have required co-investment, and US buyout co-invest is no fee, no carry. CVs take those deals out of the co-invest pipeline and turn fee-free co-invest into fee-paying co-invest through a CV. Scott has seen deals that would have gone to another sponsor, not an IPO or strategic sale, now moving into CVs. LPs who co-invested in the original deal and are allowed to reinvest must do so via the CV at full fees and carry, or exit at no fee.

“The market for buyout co investment, at least in The US is no fee, no carry. This has effectively been taken out of the co invest pipeline. This is effectively cannibalizing fee free co invest because now it's fee paying co invest via a CV vehicle.”at 23:39

Scott Ramsower · Teacher Retirement System of Texas

CVs sell top assets early at low underwritten multiples, forfeiting the LP right-tail upside.

GPs often create CVs once an asset reaches 3x, 5x or higher inside the fund. Most CVs Scott sees are underwritten to only about another 2x. His example is an asset sold at 5x out of the fund and underwritten at 2x in the CV; had it stayed in the original fund it would have been a 10x deal. The right-tail skew of the best assets is the core reason LPs invest in private equity, so moving those assets into standalone CVs at lower underwritten returns frustrates LPs who are only exposed to the original fund.

“most CVs I've seen are underwritten to at least another two x. This is an asset that was sold at a five x out of the fund, is being underwritten at a two x in a CV. Had that stay in the original fund, that would have been a 10 x deal.”at 25:27

Scott Ramsower · Teacher Retirement System of Texas

If CVs spread industry-wide, best assets leave commingled funds and could pressure PE returns broadly.

Extending the right-tail argument across the whole industry, Scott says CVs could put downward pressure on private equity returns. The best assets are being systematically taken out of commingled funds and moved into standalone CVs before their final exit and before the value creation story is over. He cites data suggesting LPs are selling more than they are rolling, which leaves the LPs who are only exposed to the original fund without access to the outsized returns. The point is framed as a possibility ('could') rather than an established fact.

“If you take that last philosophy and you apply it across the whole industry, CVs could have downward pressure on private equity returns industry wide. These best assets are being systematically taken out of commingled funds and moved into standalone CVs before their final exit.”at 26:02

Scott Ramsower · Teacher Retirement System of Texas

CVs cannot solve the zombie fund backlog; stranded assets far exceed CV capital, so the drag lasts years.

Scott describes zombie funds as ones that have stopped making new deals and cannot raise capital, with no growth in assets. Survey data he cites shows 54% of LPs expect more zombie funds in their portfolios in two years, up from 28% two years earlier. The root cause is a structural vintage problem: 2018 to 2022 vintages deployed capital in a low-rate, high-multiple environment and could not exit in time, and the math no longer works on exits. CVs mostly kick the can down the road. There are far more stranded assets than capital for CVs, and the economics are misaligned because GPs keep collecting fees on NAV that has not converted to cash.

“They were not able to exit those deals in time. That environment no longer exists. The math doesn't work on exits. As a result, there's a structural DPI problem. That backlog is gonna take years to work through the system.”at 30:42

Scott Ramsower · Teacher Retirement System of Texas

Held-at-cost PE deals no longer reliably reach 2x; unrealized portfolios now need deeper underwriting.

When markets were rising, a private equity deal held at cost was assumed to reach 2x, but that is harder to assume now. Because of this, Texas Teachers is underwriting unrealized portfolios far more deeply: checking the entry multiple paid, EBITDA and revenue trajectories since entry, actual versus budget asset by asset, current leverage, where the portfolio's credits trade, and where secondary bids for LP interests are trading. He notes there is much less liquidity and far fewer distributions, and a much larger unrealized portfolio to assess.

“It was easy to assume when markets were up into the right that a deal held at cost would get to two x. That's harder to assume now.”at 37:24

Scott Ramsower · Teacher Retirement System of Texas

Many PE GP partnerships are untested after a decade-plus boom; cracks surface when deals underperform.

Texas Teachers is assessing whether GP partnerships will hold together when conditions get tough. Partners get along easily in good times, but partnership cracks show up when a deal underperforms, when carry is at risk, when a next fund comes in smaller than expected, or when staff must be let go. He argues many partnerships have not been tested because the last ten to fifteen years were good for private equity and many firms were founded in that period, so partnership dynamics are now a significant part of underwriting.

“A lot of these partnerships haven't been tested. The last ten, fifteen years have been good times for the private equity industry.”at 39:03

Scott Ramsower · Teacher Retirement System of Texas

Public IPOs are weak PE exits; LPs are not encouraging GPs to exit that way since liquidity is partial.

Outside a couple of large growth-capital names, Scott has seen little public market activity for PE exits. Texas Teachers is not encouraging its GPs to exit through the public markets, because it can be hard for them to fully exit. He calls an IPO step one of a multistep exit, since full liquidity is rarely available on day one. This combined with the CV and zombie fund dynamics is why he expects the exit bottleneck to persist.

“Outside of a couple large scale growth capital names, we haven't seen a lot of activity in the public markets. We're not encouraging our GPs to go and exit through the public markets because it can often be hard for them to fully exit. I call an IPO step one of a multistep exit because rarely can you get full liquidity on day one.”at 32:30

Scott Ramsower · Teacher Retirement System of Texas

Semi-liquid quarterly PE funds for retail are the right strategy with the wrong structure; they erode the long-term horizon.

PE's advantage over public markets is that companies can stay focused on the long term. Putting private equity into semi-liquid quarterly redemption vehicles removes that long-term horizon, since illiquidity is a feature, not a bug, of the asset class. Scott cites the saying 'private equity for the retail investors, the right strategy, but the wrong structure,' because institutional and retail investors have different risk profiles, liquidity needs, time horizons and expertise but sit side by side in the same assets. He also flags the need for hard caps on how much a commingled fund can share with a retail vehicle, because an uncapped retail allocation effectively makes the fund uncapped.

“One of private equities advantages over public markets was that companies can stay focused on the long term. Putting these into a semi liquid quarterly redemption vehicle takes away that long term horizon. Illiquidity is a feature, not a bug of the private equity asset class.”at 34:15