Investor interest in co-investments has surged as more limited partners (LPs) and general partners (GPs) recognize the unique benefits it offers. In 2022 alone, private equity co-investments amounted to an impressive $50 billion, according to Cambridge Associates.
This guide addresses key questions around co-investing, providing valuable insights for investors considering this strategic path.
1. What Are Co-Investments?
Co-investing allows LPs to invest directly alongside a GP in a portfolio company. These opportunities often arise when GPs seek to syndicate part of their stake. Typically, LPs are invited to review and commit to deals within a short timeframe, usually four to six weeks. The emergence of “co-underwriting” has also allowed LPs to join deals before exclusivity is secured, offering faster-moving opportunities that may require due diligence in real time. Depending on the deal structure, LPs may commit through a special purpose vehicle (SPV) or directly acquire equity, with each option presenting its own governance considerations.
2. Why Co-Investing Benefits Both GPs and LPs
For GPs, co-investing helps manage concentration risk and allows for larger asset acquisitions, particularly in buy-and-build strategies. For LPs, co-investments often carry lower fees than traditional fund commitments, and may come with no management fees or carried interest. In addition to cost savings, LPs gain greater control over their investment exposure, which can be tailored to specific sectors, regions, or strategies. Co-investing also provides LPs with a closer look at the GP’s investment process, enhancing transparency and relationship building.
3. Setting the Right Co-Investment Policy
To capitalize on co-investing, investors should allocate a strategic portion of their portfolio to co-investments. Tactical allocations can be flexible but may lead to missed opportunities if not consistently deployed. A strategic allocation, recommended at around 15-30% of private equity exposure, allows for steady pacing and diversification, while helping to mitigate risks.
4. Implementation Approaches
Investors have several options for implementing a co-investment strategy. Larger PI portfolios often provide sufficient deal flow, enabling in-house teams to manage investments directly. Medium-sized portfolios may benefit from appointing specialist co-investment managers who can expand access and streamline due diligence. Smaller portfolios might find a commingled co-investment fund more effective, as it provides diversified exposure and access to experienced sector specialists.
5. Common Pitfalls and Challenges
Successful co-investing requires more than just capital; it demands expertise, bandwidth, and timely decision-making. Investors should avoid a blanket approach, instead carefully evaluating each opportunity to avoid adverse selection and concentration risk. Transparency with GPs is also essential, as backing out late can strain relationships. While co-investing can deepen GP-LP relationships, clear communication and alignment are key to building mutual trust.
6. Other Key Considerations
As co-investing evolves, investors must remain adaptable. This includes understanding diverse structures, such as SPVs and direct acquisitions, and being prepared for unexpected developments. Whether managing additional financing needs or responding to GP-driven changes, co-investors must stay actively involved throughout the investment lifecycle. Venture and real estate co-investments, for example, present unique challenges, including higher risks and specific fee structures, which should be factored into strategic planning.
Co-investing offers a path to enhanced returns and greater control, but it requires careful consideration of strategy, implementation, and ongoing management. For investors prepared to navigate the complexities, private equity co-investments provide a valuable avenue for growth and portfolio diversification.
