It's a nightmare from a valuation standpoint, because while many LPs may well be invested in both funds, making it a wash, some are not. The LPs that invest in both funds sign a check to fund the investment in the new fund, and then get the money back as the older vintage is winding down. The investment just essentially gets rolled forward. The investors who are only in the new fund are cashing out the previous investors, so this is much more of a concern. But they are new and still usually riding the feeling of wow, they let me invest in this awesome fund. PE firms are really good at creating an aura of exclusivity and luxury.
A rolling loan gathers no loss. So long as the music keeps playing, valuations can be whatever number you can get your auditor to agree to. Nice dinners and event tickets for your audit partner can help with that.
And tbh there would be some other LPs cashing out the previous investors if the company was sold normally. The only LPs who take this risk are the ones who buy into the new fund. And if they're worried they should just check the GP commit, if it's thin then obv they're just pulling fees so don't invest. Some of the continuation funds the GPs actually believe they have a really good investment and they increase their commit as a %.
And the increasing valuations you describe are literally the same as the public markets the past few years. No bribing audit partners required.
Their ability to withdraw/redemption is often heavily constricted too.
(I’m not making an opinion on GP behavior yet)
More importantly literally all LPs have to do is not invest in the continuation fund. It costs them 0 money extra to close out their position in the old fund and leave. Continuation funds are 100% optional.
Also IMHO continuation funds can be useful if a PE firm thinks it has a real winner. It's harder than you think to find good places to place a lot of money so it will grow so I can understand why LPs might go for it in some cases.