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The New Normal – Co-Investments in Private Equity

Do not expect co-investment demand to go anywhere anytime soon – according to a recent report by CEPRES, private equity co-investments have increased 20-fold over the last 17 years. The boom of private equity co-investments can and should be viewed as a win-win for both general and limited partners.

More and more we are seeing our clients offer co-investments to their investors, and while the demand and appetite for co-investments stems from several contributing factors, it is predominantly being driven by investors’ appetite for increased exposure to deals.

Beyond this, there are several reasons our clients continue to engage in co-investments:

  • Additional exposure
    • Co-investment opportunities allow the investor to identify deals, which provide them exposure to sought-out investments types and/or sectors.
  • Increased returns
    • A 2015 Preqin report demonstrated that 80% of Private Equity investors saw their co-investments outperform their fund investment, some by more than 5%. Additionally, the 2018 CEPRES analysis indicated that co-investments deliver better TVPI multiples than IRR returns.
  • Cost-effectiveness
    • Typically, sponsors will offer reduced management fees and carried interest, if any, to the investor, further decreasing the expense ratio for the investor.

There are not only benefits to the investor to have access to co-investment opportunities – a good investor/manager relationship is a two-way street, and co-investments provide several benefits for the GP.

  • Additional capital to work with
    • Extending co-investment opportunities to investors allows a manager to make an investment in a portfolio company that they may not have been able to execute on given the terms outlined in the fund documents. For example, fund documents indicate a single investment will not exceed $50M, but the potential investment requires more capital to complete the deal. The manager can identify co-investors to complete the deal.
  • Goodwill to potential investors
    • By offering a potential investor a co-investment opportunity, the manager is providing the investor insight into their due diligence process, their deal sourcing process, etc. It may be a way to secure future financing opportunities.

While co-investments provide many upside opportunities, there are other considerations – for example, a manager should develop some type of strategy when considering offering co-investment opportunities to investors. Will all investors be offered these opportunities? When will co-investments opportunities be provided? How will potential co-investors be identified and granted?

Lastly, the exit strategy for each investment should be determined and disclosed. Typically, our clients offer their investors side-by-side treatment, where the investor receives the same terms and conditions of the exit as the sponsor.

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Jaclyn Greco is a Financial Services Group Manager providing business consulting services to alternative investment funds, including hedge, private equity, and venture capital funds, primarily situated in the pre-launch stage.

Ryan Raben is a Partner in the Financial Services Group with diversified accounting and auditing experience for private equity funds, venture capital fund, funds of funds, broker-dealers and hedge funds, as well as investment advisors.