When private equity firm Triton Partners created its first continuation fund in 2021, most investors were relieved.
With the fund in its 13th year, this was a chance to cash out rather than keep their capital locked up in a tail of portfolio companies proving tricky to sell.
Triton would pay them out by selling these assets to itself, setting up a dedicated fund for the purpose and bringing in new outside investors to set the price.
Almost all of the backers of the original Triton fund opted to take the cash rather than hang on to their stakes. Of about 50 investors in the original fund, only five chose to invest in the continuation vehicle.
That decision would prove costly. The original investors missed out on substantial returns as assets were quickly refinanced or sold at prices well above what Triton had predicted might be possible.
Triton’s continuation vehicle is just one example of a structure that has become commonplace as private equity struggles to exit its investments. But it highlights wider concerns within the industry that these deals can ultimately disadvantage one set of investors over another.
In the 2021 deal, Triton and its executives took a different approach to their external backers. Some executives chose to sell. But collectively the group reinvested an amount broadly in line with their proceeds and carried interest from the sale of the assets into the continuation vehicle.
The continuation fund was a fraction of the size of the original fund, at just €336mn compared with the original €2.4bn. So the proportions of capital invested in the continuation vehicle by members of the Triton team — led by founder and chief executive Peder Prahl — increased as much as eightfold, compared with the capital they had originally invested at the outset of the old fund.
Investors in continuation vehicles expect private equity firms and their executives to have significant skin in the game, Triton said, so putting proceeds from the old fund into the new one was in line with market practice.
Some executives increased their stakes to cover other colleagues who wished to cash out, a person familiar with the firm said.
The increased stakes created the potential for significant gains should the continuation fund assets perform better than expected. Those opting to sell — including most of the external investors in Triton’s original fund — would miss out if gains emerged.
Within months, the continuation vehicle extracted about €60mn in gross proceeds from one asset through a refinancing: an amount roughly equal to what it had paid for it. Other deals led to another asset returning roughly double what Triton had told original investors it expected to generate, and another 20 per cent more.
In all, Triton has within four years managed to generate close to €550mn in gross proceeds from sales and refinancings of the assets that it had placed in the continuation vehicle.
Proponents argue continuation vehicles offer private equity’s institutional backers much needed liquidity and keep capital flowing.
The Triton continuation fund does however also highlight the possibility of conflicts of interest inherent to the structure, and speaks to concerns from some investors that they are at a disadvantage when judging whether to stay invested or sell out.
“The [private equity manager] sits on the board . . . has done the full diligence on the buy, they’re in the companies day in and day out,” said the head of private equity at a large US pension plan. “By definition” firms had more information than fund investors, they added.
Triton told the Financial Times that it had worked closely with its advisory board to carefully manage the position on conflicts of interest. Investors were supplied with detailed information about portfolio companies and told how perceived conflicts were being managed.
None of the external investors which cashed out raised concerns with Triton that either the process of setting up the continuation vehicle or its results were irregular or improper, the firm said.
Triton Partners was set up by Prahl in 1997, and has raised more than €21bn of capital to deploy across business services, industrial technology and healthcare investments.
The firm has had its challenges, notably around culture. Prahl this year apologised publicly after German newspaper Handelsblatt reported that he had taken off his shirt and taken part in a game of “spin the bottle” at a company party in 2022.
Fund III was a 2009 vintage fund, typical of the firm’s strategy of targeting small and mid-market businesses. The fund overall performed well, and had cleared the hurdle needed to start generating the performance fee known as carried interest.
But it held some assets Triton said were trickier. Originally due to return investors’ capital within a decade, the fund was extended once, and then a second time. Then Triton pitched its backers — known as limited partners — on the continuation vehicle.
Triton Fund III had contained around 20 investments, according to data provider PitchBook. By 2021, the fund still had eight that it had yet to realise — companies that Triton said it had made numerous attempts to sell or refinance, largely unsuccessfully, before considering the use of a continuation vehicle. Of those, four would ultimately end up in the vehicle.
These were Finnish search provider EDSA, water-supply-chain parts maker Talis, flooring manufacturer Kährs and engineering company Dywidag.
With extra time, Triton hoped to extract more value from the assets. In March 2021, its advisers prepared pitch documents to market the proposal to investors.
In those documents, Triton set out three things, among others: the proposed base prices for the assets being put into the vehicle; what it thought each of them could fetch when later sold; and how long it was likely to take before those sales could be achieved.
“Given historical challenges in some companies, the manager believes that additional time will allow it to drive these companies to their full potential,” a draft presentation read. Existing backers had 20 business days to decide whether to cash out or invest in the continuation fund.
For EDSA, the presentation valued the equity that the continuation vehicle would acquire at €116mn, and forecast that it would be sold by March 2025 for about €323mn in gross proceeds.
With Talis, the company’s equity value was estimated at €27mn with the vehicle predicted to receive €54mn in gross proceeds upon sale, expected to take place by December 2023.
Triton and its advisers did not set the price that the continuation vehicle would pay for the assets. New investors bid to invest through an “independent auction” process conducted by an adviser that followed market practice, Triton said.
“The highest bidder set the final sale price, which was a premium to the fund’s latest fair value. Triton had no influence on the price for this auction,” the firm said.
The sales to the continuation vehicle happened at a 3 per cent premium to the base prices in the presentation, a person familiar with the firm said.
All original fund investors received “the same extensive due diligence information” as the new backers, plus the chance to invest in the continuation vehicle, Triton added.
But many traditional investors in private equity funds lack expertise in assessing the value of individual portfolio companies and their likely future performance. They focus on analysing the quality of private equity managers, and entrust them with choosing individual potential investments for the fund.
Triton told the FT that the continuation vehicle as a whole was today performing as originally expected.
Both the EDSA and Talis investments would perform far better than Triton had forecast, however.
In March 2023, just 19 months after the sale to the continuation vehicle completed, Triton sold a subsidiary of EDSA. That one sale generated more than €300mn in gross proceeds, a total that climbed to about €394mn when Triton sold the last part of EDSA in early 2024, according to people familiar with the matter.
With Talis, they said, Triton generated about €95mn in gross proceeds through a series of sales — almost double the original prediction.
One person familiar with Triton said that EDSA had performed unexpectedly well, and it was hard to predict possible buyers or exit valuations, especially when businesses are sold in parts.
The vehicle still holds two investments, flooring maker Kährs, and engineering business Dywidag.
Within two months of the continuation vehicle closing, Triton lifted its forecasts for Kährs’ 2022 earnings by 12 per cent, according to another presentation. Kährs then paid out about €60mn — close to what the fund had paid for the business — through a dividend recapitalisation, according to further documents and a person familiar with the matter.
Swedish outlet Affärsvärlden first reported the Kährs transaction.
Dividend recapitalisations are a type of refinancing where a portfolio company takes on debt and pays out money to shareholders.
The firm had told potential continuation vehicle backers that a refinancing could happen, the person familiar with Triton said.
They said the transaction would not have been possible in the old fund without additional capital to support the company. Other private equity executives and lenders took a different view. Dividend recapitalisations were generally “asset — not fund — led”, said one.
The person familiar with the firm added Kährs had short lead times for its orders, making it hard to predict performance. It had since struggled for macroeconomic reasons, they added.
Even without a sale, the recapitalisation meant that a substantial part of the economic value of Kährs is likely to have been recouped by investors.
The continuation vehicle bought the three assets for just over €210mn. Combined, the sales of Talis and EDSA and the refinancing of Kährs secured gross proceeds close to €550mn.
The economics of continuation funds are complex. Once the original fund has sufficiently good returns, a performance fee — carried interest — kicks in. That means the private equity team typically receives 20 per cent of the profits on top of the share of proceeds from any sale to which their equity stake entitles them.
So there is an argument that, when a fund is in carry — as Triton Fund III was — dealmakers have a greater economic interest in the assets than their mere equity stake would suggest.
When those assets are sold to a continuation vehicle, dealmakers are expected to roll both their proceeds from that sale and the carried interest earned on it into the new fund — as Triton’s executives did, on aggregate.
The Triton III Continuation Fund offered a fresh opportunity to earn carried interest for the executives that opted to participate, however.
Continuation vehicles do not normally clear the return hurdle that unlocks performance fees before their third or fourth year, people in the industry said.
In this case, a person familiar with the matter said that the EDSA, Talis and Kährs deals meant that the vehicle cleared the hurdle in just over two.