Unlocking Private Equity Co-Investment Opportunities: What You Need To Know

Private equity co-investment opportunities are a type of collaborative investment structure in which a private equity firm and external investors collectively invest in a private company. They are typically restricted to large institutional investors who have a relationship with the private equity fund manager. Co-investments are passive, minority positions that allow investors to invest in a private company on the same ownership terms, usually in line with the percentage of their investment, as the general partner (GP). Co-investors are often charged reduced fees for the investment and receive ownership privileges equal to the percentage of their investment.

How do co-investments work?

Co-investments are a type of investment structure where a private equity firm (known as the general partner or GP) and external investors (known as limited partners or LPs) collaborate to collectively invest in a private company. This structure allows multiple parties to pool their financial resources, expertise, and networks to make a joint investment and share in the potential profits.

Co-investments typically involve a private equity fund manager or venture capital (VC) firm making a minority investment in a company, with other investors participating alongside them. These co-investors are usually institutional or high-net-worth individuals who have a relationship with the private equity fund manager.

In a traditional private equity fund, investors become limited partners in the fund and entrust the day-to-day management of the fund to the general partner. However, in a co-investment structure, the investment is made directly in the portfolio company, giving co-investors passive, minority positions. This means they have limited control over the investment and typically cannot make decisions about the fund.

Co-investments are often made outside the existing fund structure, and co-investors usually do not pay management fees or carried interest on their individual investments. Instead, they benefit from the expertise, deal-sourcing capabilities, and network of the private equity firm. Co-investments can provide access to alternative assets and equities, as well as potential exposure to new markets and investment options that may not be available to average investors.

From the perspective of a private equity firm, co-investments offer several advantages. They provide a source of supplementary capital, allowing the firm to make larger single investments. Co-investments also enable the firm to share investment risks and access additional investor capital. Additionally, offering co-investment opportunities can be an incentive for investors to invest in future funds.

For investors, co-investments offer the potential for enhanced returns, diversification, and access to the expertise of private equity firms. By participating in different co-investment opportunities, investors can reduce their exposure to specific risks associated with any single investment.

What are the benefits of co-investing?

Co-investing offers a range of benefits for investors and private equity firms alike.

Benefits for investors

Co-investments can lower the risk of losing money through widespread fund-of-fund investments. By partnering with reputable private equity firms, investors are more likely to control the risk of losses since the private equity firm drives most of the deal sourcing and due diligence to de-risk the investment.

Co-investments also give investors more control over investment decision-making, which can lower risk and increase their involvement in determining an asset's growth. The ability to choose which deals to join allows investors to build across geographies and strategies.

Co-investments are a good portfolio diversifier, allowing investors to reduce their exposure to specific risks associated with any single investment. They can also provide exposure to different types of investments, such as buyouts or growth equity, further enhancing diversification.

Co-investors can benefit from the rigorous due diligence, operational improvement strategies, and value-creation techniques of private equity firms. The firms' specialised knowledge, industry insights, and extensive networks can contribute to successful investment outcomes.

Benefits for private equity firms

Co-investments allow private equity firms to make larger investments without dedicating too much of the fund's capital to a single transaction or sharing the deal with competing firms. They are a friendly source of supplementary capital, which can be used to make larger single investments that would otherwise be unavailable or undesirable.

Co-investments bring in additional capital for larger investments, strengthening a firm's positioning when investing in a company. They also increase access to investor capital and offer marketing and investor relations benefits with specific investors outside of the main private equity fund.

What are the risks of co-investing?

When considering a private equity co-investment opportunity, it is essential to understand the associated risks. Here are some key risks that investors should be aware of:

Market and Investment Risk: Co-investors are exposed to market risks, including industry-specific, economic, and geopolitical factors that can impact the performance of the invested business. Private equity investments are often illiquid and long-term, making it challenging to exit the investment quickly if market conditions turn unfavorable. The value of the investment may fluctuate, and there is a risk of losing some or all of the invested capital.

Concentration Risk: Co-investing typically involves investing in a single company or a small number of businesses as part of a private equity fund's portfolio. This lack of diversification can lead to concentration risk, where the performance of a single investment has a significant impact on the overall returns. If the co-invested company underperforms or faces challenges, it can disproportionately affect the investor's portfolio.

Lack of Control and Dependency on Lead Investor: In a co-investment structure, the lead investor or private equity fund manager typically makes the key decisions regarding the investment. Co-investors often have limited influence over the investment strategy, operational decisions, and exit timing. This dynamic can create a dependency on the lead investor's expertise and integrity, and any missteps or conflicts of interest on their part could negatively impact the co-investors.

Limited Liquidity and Long-Term Commitment: Private equity co-investments are generally illiquid, and investors should be prepared to commit their capital for an extended period, often ranging from 5 to 10 years or more. Early redemption or exit options may be limited or non-existent. Investors need to carefully consider their liquidity needs and ensure that they can commit the necessary capital for the long term.

Information Asymmetry and Due Diligence: Co-investors may face challenges in accessing comprehensive and accurate information about the investment opportunity. The lead investor or fund manager typically conducts due diligence, and co-investors may rely on their assessment. This information asymmetry can put co-investors at a disadvantage, as they may not have the same level of insight into the investment's risks and potential as the lead investor.

Fee Structures and Carried Interest: Co-investment structures may involve fee arrangements, including management fees and carried interest, which can impact the overall returns. It is important to carefully review and understand the fee structure to ensure it is aligned with the investor's expectations and does not erode the potential returns. Carried interest, in particular, can result in a significant portion of the profits going to the fund manager or lead investor.

In conclusion, while private equity co-investment opportunities can offer attractive potential returns, investors should carefully consider and manage these risks. Conducting thorough due diligence, understanding the fee structure, diversifying investments, and carefully selecting lead investors with strong track records can help mitigate some of these risks. It is essential for co-investors to be aware of the challenges and potential pitfalls to make informed decisions and protect their capital.

Who are co-investors?

Co-investors are typically institutional or high-net-worth investors who make their investments alongside private equity firms or venture capital firms. They are usually existing limited partners in an investment fund managed by the lead financial sponsor in a transaction.

Co-investors are often large institutional investors who have a relationship with the private equity fund manager and are not usually available to smaller or retail investors. They are generally high-net-worth individuals and institutional investors, such as endowments, pension funds, and corporations.

Co-investors provide a minority stake in an equity co-investment (less than 50%) but have no decision-making or voting power on how the investment or fund is operated. They are passive, non-controlling investors as the private equity firm or firms involved will exercise control and perform monitoring functions.

Co-investors are charged a reduced fee for the investment and receive ownership privileges equal to the percentage of their investment. They can also gain more control over their private equity portfolios. Investors with specific geographical or sector insight, for instance, can leverage their knowledge by choosing deals that map onto their expertise.

Co-investors are an attractive option for private equity firms as they allow managers to make larger investments without either dedicating too much of the fund's capital to a single transaction or sharing the deal with competing private equity firms. Co-investors bring a friendly source of capital.

How do co-investments fit into your portfolio?

A fund that exclusively or partially contains co-investments can be a smart way for investors to diversify their portfolios and potentially earn high returns. Here are some of the benefits:

Potential for Enhanced Returns

Co-investments have the potential to generate attractive returns. By accessing deals typically reserved for private equity firms, investors can participate in investment opportunities that have strong growth prospects, favourable valuations, or strategic advantages. Co-investments may also have lower fees compared to traditional private equity funds, potentially increasing net returns.

Diversification

Co-investments may provide portfolio diversification. By participating in different co-investment opportunities across various industries, sectors, and geographies, investors can reduce their exposure to specific risks associated with any single investment. Co-investing alongside a private equity firm can also provide exposure to different types of investments, such as buyouts or growth equity, which can further enhance diversification.

Access to Expertise

Private equity firms often have specialised knowledge, industry insights, and extensive networks that can contribute to successful investment outcomes. By co-investing, investors can benefit from the firm's rigorous due diligence, operational improvement strategies, and value-creation techniques.

Risk Mitigation

Co-investments allow investors to share the risk associated with a deal. They also allow managers to make larger investments without dedicating too much of the fund's capital to a single transaction.

Flexibility

Co-investments can give investors more flexibility in portfolio construction. They can also provide flexibility in terms of the pace of deployment, allowing investors to temper their investment pace in line with their risk appetite.

Frequently asked questions