Private Equity Co-Investment: What, How It Works, Pros and Cons

Discover the advantages of private equity co-investments with Paperfree.com. Learn how co-investing can enhance your portfolio, diversify your holdings, and potentially boost your returns. Explore the opportunities and insights into private equity co-investments in this comprehensive guide brought to you by Paperfree.com.

last updated Thursday, September 21, 2023
#co investment #co investment private equity

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John Burson

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CONTENTS

Understanding private equity co-investments

What are co investments?

The co investment private equity is a direct investment in a company by the fund's limited partners (LPs) to a specific transaction and not through the fund. That investment run is a separate vehicle governed by different contrasts and agreements.

Where:

• Limited Partners are represented by institutional investors: family offices, funds of funds, foundations, etc.
• The investment is a part of the alternative asset space.

Examples of co-invest transactions

There are three main types of coinvestment transactions, include:

• capital growth initiatives,
• recapitalizations, 
• leveraged buyouts.

Example #1. AvCellera Biologics

AbCellera Biologics made a C$701m co-investment with the British Columbia, Canada 🍁 government to drug development, manufacturing, and clinical research on May 24, 2023.

AbCellera Biologics company will co-invest C$401m, and British Columbia, Canada 🍁government will contribute C$225 million and C$75 million over the next eight years.

Source - Reuters

Example #2. Mintec

Schroders Capital co-invested with growth investor Synova to company Mintec in April 2022, when the Ukrainian crisis began and commodity prices increased.

Mintec sells a software product allowing real-time consultation of price trends of commodities not traded on the major indexes.

Source - Schroders Capital

Example #3. Easypark

The first investment in EasyPark was made in 2018; it has grown quite rapidly.
Easypark first relied on a buy-and-build private equity strategy to become a local leader. It then grew to become a global leader.
Schroders Capita reinvested in EasyPark in 2021 when Easypark acquired ParkNow, a player with significant exposure in the US, UK, and Benelux.
Easypark is a mobile payment application for public parking. The company was founded in 1998 in Sweden and has since expanded.

Source - Schroders Capital

How does co invest work?

1. LP sets co-investment goals. 
   
   The LP investor establishes investment criteria: return expected and the level of control. Setting up clear goals in advance helps to match with the best-fit co-investment opportunity. A clear goal allows all parties to monitor the marketplace better and make timely and correct decisions.
   
   
2. Communication  GP<>LP.
   
   LP investors in a PE fund will often indicate in the subscription agreement or a side letter entered into with the fund whether it is interested in co-investment opportunities. Such election by the LP is informational and should not impose any obligation on the fund's general partner.
   GPs will offer co-investments to some or all of the LPs. Co-investments may provide LPs with a bigger stake in investments of interest without as much of the diligence and procedures typically associated with an investment opportunity.
   LPs may also access enhanced due diligence or GP materials that would otherwise be unavailable, allowing for deeper understanding and enhanced tailoring of such LP's investment portfolio. From a fund's perspective, sharing investment risk, increased access to investor capital, and the marketing and investor relations benefits with specific investors outside the main PE fund are additional attractive characteristics.
   
   
3. I am setting up the legal framework.
   
   A framework for co-investment by the main PE Fund should be carefully considered and mapped out at an early stage to communicate to LPs concisely and as early as possible. This is often accomplished through a separately structured co-investment vehicle, which is governed by a separate set of agreements. Co-investments are structured with similar governing documents to those of the leading PE fund. The nature of the co-investment relationship, and the interplay with the main PE fund, should be accounted for, including as it relates to the allocation of expenses and payment of fees, apportionment of opportunities, voting, and management responsibilities.
   
   
4. Setting up the tax matters.
   
   Co-investment vehicles should be used for tax planning efficiency. The tax and regulatory aspects of the fund, investment, and investors are known at the time of the transaction; parties have the ability to customize co-investment structures to account for tax-related considerations well in advance. Tax advice should always be sought when addressing particularities of structure, including relating to the provision of management services, auditing, and reporting obligations.
   
   
5. Compliance Other considerations.
   
   Regulatory issues, including reporting requirements and compliance with jurisdictional securities laws. Co-investors may also be faced with regulatory concerns that can be transaction or industry-specific, commonly including telecommunications, gaming, or publishing industries. Compliance with investment mandates and fund goals in order to create synergy between co-investor and fund interests.
   
   
6. Cost negotiation
   
   Costs to the investors, including transaction fees, payment of carry, and management fees.

Co-Investment vs. Joint Venture

Perspective	Joint Venture	Co-Investment
Benefit	Enter into new markets	Access private equity at low fees
Investment management	Collaboration	Managed by the fund manager
Benefit	Enhances capacity and capabilities of partners	Portfolio diversification
Benefit	Shared risks and costs	Fund managers obtain regular incentives

Table: comparing co-investment and joint venture models

Co-Investment vs. Direct Investment 

Perspective	Direct investment	Co-Investment
Number of investors	Multiple investors partnering with deal fund manager	Single investor
Risk management	Risk is owned by a single investor	Risk is spread between investors
Investment management	Managed by an independent investor	Managed by the fund manager

Table: comparing co-investment and direct investment

What are the pros of co-investment?

Co-investment arrangements can provide benefits and value to both the fund's LPs and PE. And be attractive for a multitude of reasons, including:

LP Perspective

• Fee savings. Co-investment offerings come with reduced economics compared to a traditional primary fund, thus providing the potential for more attractive returns.
• Enhanced due diligence. Double due diligence can have an impact on performance. LPs access to GP materials and enhanced due diligence allow for deeper understanding and enriched tailoring of specific investments to the entire portfolios.
• Enhanced diversification. Being a large investor provides access to a wide array of general partners and the ability to determine portfolio construction across managers, sub-strategies, sectors, and geographies. LPs to attain enhanced diversification and a larger share of desirable investment.
• More control. Co-investing is popular among investors who seek greater control of their fees and involvement in their investments. Co-investing also gives the opportunity to engage more actively with the companies, such as on sustainable practices and behaviors.

GP Perspective

• Operational efficiency. The co-invest strategy needs fewer investors to communicate and serve, which positively impacts managers' operating model.
• New working capital. PE funds can access supplementary capital if they have designed vehicles and are ready to onboard co-investment transactions.
• The speed of investment. Managers can move faster, relying on fewer investors to comply.
• More closed deals. The co-investment strategy allows funds to make larger single investments that are otherwise unavailable or undesirable.

To summarize the pros of co-investment.

Investors who desire more control and involvement in their investments often benefit from co-investment. However, it is important to consider the strategy's challenges.

What are the cons of co-investment?

However, there are a few challenges in today's market and generally in such transactions.

• Market saturation. The market for co-investors has become saturated, and the quality of co-investors varies widely.
• Regulations. However, the majority of co-investors are "passive" rather than leading or underwriting the deal. This has caught the attention of the SEC, which is reviewing and considering new regulations to address such differences.
• Conflict of interest. Another potential issue with co-investment is the potential for conflict of interest. GPs may over-allocate co-investment opportunities to potential future fund investors, leading to "sweet deals" and an unfair advantage. Furthermore, when co-investors dilute the stakes of major fund investors, potential conflict can arise within the fund structure.
• Fast-paced environment. Ability to be a good co-investment partner, including making quick initial decisions, allowing for the ability to monitor, review, and adapt to changing information, and establish internal processes and procedures for investment decisions and monitoring.

Drives of co-investment strategy growth.

• LPs reported better performance from equity co-investments compared to traditional fund structures. Preqin's latest survey of fund managers and investors examines the increasing appetite for co-investments among both parties. It finds that 80% of limited partners have seen their co-investments outperforming private equity funds.[1]

• GP uses co-investments as a way to improve relationships with LPs, gain access to more capital for deals, and improve the chance of a successful fundraiser. GP's co-investment offerings are also becoming more common, with 87% of managers either currently offering or considering offering co-investment rights to their investors. Furthermore, 30% of managers included co-investment rights in 81-100% of limited partnership agreements in their most recent fund.

2023 Update 

Global private markets fundraising has slowed down.

2021 was the highest record achieved.

2022 was a quiet year in the private markets compared with the decade of growth.

As per Pitchbook data, the total capital raised for co-investments with PE investment managers has increased from 4 billion US dollars in 2010 to 10.3 billion US dollars in 2022.

2022 was a high inflation year, pushing worldwide central banks to increase interest rates at a historic pace. Quantitative tightening and dislocation in asset prices raised fears of an economic slowdown. 
The war and humanitarian crisis in Ukraine further enhanced the risks to the global economy. 
Public markets sold off substantially. Private markets remained relatively optimistic in the first half of the year but followed the public market in the second half. These disruptions had substantial and varied impacts on private markets fundraising, performance, and AUM growth, with steep declines in specific regions and strategies and pockets of resilience in others.
The biggest decline in private market fundraising was in Asia and Europe.
North America's market experienced a slight increase (Chart 10). 

Chart 10. Global markets fundraising.

Co-investing shifted to larger vehicles.

Chart 11. Private market. Capital raised and a number of funds.

During 2022, the number of private equity funds decreased significantly from 1,129 to 597. This was due to LPs becoming more careful about investing money and concentrating on experienced managers.

LP's investments shifted into larger vehicles as investors re-upped with existing managers while forgoing commitments to smaller and newer managers.

Newly established managers faced significant challenges, with the fundraising for first-time private equity funds reaching its lowest point in the past nine years.

To fill the equity gap, GPs turned to the co-investment market. This strategy also enabled PE managers to dedicate additional time to raise their subsequent commingled funds. Additionally, some GPs used co-investments to diversify their portfolios and extend their investment period, allowing them to be out of the market for longer.

Moreover, debt became scarcer in 2022, further increasing the demand for co-investments– propelled not only by the inclination of LPs to seek decreased fees and their demand for increased equity financing but also by the cost of debt to fund buyouts, which has occurred due to a more stringent credit market and higher interest rates.

Family offices and impact co-investment marketplace

Family offices lead the LP's team.

The inclination towards co-investment is robust, with almost two-thirds of institutional investors planning to invest alongside their GPs over the next 12 months.

Co-investment is a strategy utilized by family offices, which may involve multiple approaches such as "club" deals that unite multiple families for investments, investing alongside a PE fund but without investing in the fund itself, or collaborating with another family to invest in a business.

Globally, 42.5% of family offices are already engaging in co-investment activities. While PE and other fund structures may still be suitable for families who want to invest in less-familiar industries, the family office industry is characterized by a more personal and relationship-oriented approach than institutional investing. As a result, families are more likely to co-invest in projects and assist each other in finding investment opportunities.

Conclusion

• Co-investments are essential tools for fund managers and fund'snd's limited partners.
• Co-investments can provide the potential for higher returns for funds and LPs in the right circumstances.
• Co-investments provide greater transparency and control.
• Co-investments allow limited partners to invest in hand-picked, specific deals.

Important information

The views and opinions contained herein are those of Paperfree teams. These views are subject to change. This information is intended to be for information purposes only, and it is not intended as promotional material in any respect.

References

1. How do private equity co-investments work, and what are they used for? https://www.schroders.com/en-us/us/institutional/insights/how-do-private-equity-co-investments-work-and-what-are-they-used-for-/
2. 80% Of Private Equity Investors See Their Co-Investments Outperform Commingled Funds https://www.valuewalk.com/80-of-private-equity-investors-see-their-co-investments-outperform-commingled-funds/
3. The advantages of private equity co-investments https://www.blackrock.com/institutions/en-us/insights/the-advantages-of-private-equity-co-investments
4. Co-investment: a promising alternative to traditional private equity vehicles? https://www.ey.com/en_lu/private-equity/co-investment--a-promising-alternative-to-traditional-private-eq
5. The Rise of Family Office Direct and Co-Investing. https://www.affinity.co/blog/family-offices-direct-investing
6. Equity Co-Investment: Definition, How It Works, Benefits https://www.investopedia.com/terms/e/equity-coinvestment.asp
7. McKinsey Global Private Markets Review: Private markets turn down the volume https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/mckinseys-private-markets-annual-review
8. Private equity funds and co-investment: A symbiotic relationship https://www.nortonrosefulbright.com/en/knowledge/publications/12c81c8a/private-equity-funds-and-co-investment

 
 
 

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