I Can See Clearly Now
Typically, an investor in a blind pool private equity fund has little oversight on the deals being done by the GP. However, with co-investments, investors have greater control over their capital and have the freedom to decide whether a specific asset is appropriate for their strategy. For instance, an investor can focus on specific sectors or regions. Additional control means that investors can hold some sway on the length of time an investment is held or how the target business is run. Equally important to a co-investor is the ability to sit out an investment opportunity if it does not fit its risk profile. Depending on the transaction, co-investors may play an important role in the due diligence process. In some cases, it may not be practicable for the GP to provide coinvestors with access to the due diligence process, but in some circumstances, particularly where the investors have specialist knowledge in a particular field, the GP may welcome the input. Finally, co-investing provides an investor with an insight to the GP's due diligence and decision making process, which may shape its decision on whether to back the GP in a future blind pool fund. If an investor is relying on the GP's due diligence it should seek some written assurances from the GP and its lawyers as to the veracity of its due diligence report.
Collaboration Station
Co-investments can deepen collaborative relationships between GPs and investors. This collaboration not only benefits the immediate investment, but also the long term relationship between the parties. Fund-raising has become hyper-competitive in recent years, with large established players garnering the lion's share of new capital committed to private equity funds each year. This has left many GPs short of capital needed to complete transactions. Offering co-investments gives GPs an edge over their competitors and can help fill the funding gap.
Reduced Fees
Naturally, investors will be less concerned with GP fees when the return on a fund's investment is strong. It must follow that when returns decrease, investors will start asking questions about the fund, its returns, and
the GP's fees. Co-investments are generally offered with reduced or waived management fees. A recent Preqin report found a majority of GPs reported that they charged lower management fees and carried interest on co-investment arrangements, or charged no fees at all. On the one hand, most investors are sophisticated enough to understand that undercutting the GP on fees is short-sighted. On the other hand, without reduced overall fees, the incentive to invest in a private equity fund starts to deteriorate. Co-investments, on paper at least, allay both concerns.
Increased Experience
Working alongside a GP provides investors with exposure to the investment and portfolio management process, educating investors on running their own deals in the future. Investors can dip their toes into the deal sourcing process as much as they desire, but ultimately, they are piggy-backing on the GP and following its lead. Even where an investor does not have a desire to invest directly, having demonstrable co-investment experience will enhance its reputation as a strategic partner and potentially increase allocation of coinvestment opportunities to it from the GP.
More Strings to Your Bow
Co-investments offer investors the opportunity to diversify their portfolio and increase the pace of capital deployment. In the current era of low interest rates, finding a home for capital other than a low interest bearing bank account is a huge benefit for investors. In traditional private equity funds, dry powder is running at record levels. Co-investment opportunities can offset that by opening up an alternative avenue for capital deployment
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Returns, Returns
If managed properly, co-investments can generate healthy returns for an investor as the profits are not subject to the same level of expenses and fee deductions as typical private equity fund investments. In addition, returns are likely to be seen faster than in the traditional private equity fund model. Generally speaking, all the capital committed to a co-investment opportunity is deployed on closing, as such, there is not the same dip in performance following closing that is the norm in private equity deals (where management fees are paid up on capital which is not deployed). The Preqin report we mentioned earlier found 46% of investors stating that their past co-investments have outperformed fund investments by more than 5%, in contrast to just 3% of investors witnessing any underperformance
Co-Investments: The Manual can be downloaded at https://www.mjhudson.com/wp-content/uploads/2017/05/MJHudson_Co.Investor-Guide_AW_Email_Single.pdf
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
