Private equity co-investment funds have become an increasingly popular investment option for limited partners (LPs) in recent years. As the name suggests, co-investment refers to when an LP invests alongside the private equity fund’s general partner (GP) in a portfolio company deal. There are several benefits for LPs in co-investing, such as lower fees, access to top-tier deals, and greater control. However, there are also risks such as adverse selection by GPs and lack of diversification. This article provides an introduction to private equity co-investments.
Reasons Why LPs Pursue Co-Investments
LPs are motivated to pursue co-investments for several key reasons: (1) Co-investments can generate higher returns compared to just investing in the private equity fund alone. Studies show co-investments regularly outperform regular fund investments. (2) By not paying management fees and carry on the co-investment, the costs to LPs are lower. (3) Co-investing provides LPs access to the top deals that they otherwise may not see. GPs provide co-investment opportunities in their very best investments. (4) LPs can build closer partnerships with GPs and gain more control through co-investing directly in deals.
Risks and Challenges With Co-Investments
While co-investments offer advantages, LPs also face risks including: (1) Adverse selection by GPs who may keep the best investments for themselves rather than offer co-investment opportunities. (2) Diversification can suffer due to more concentration risk. (3) LPs must conduct quicker due diligence with less information provided by GPs. (4) Co-investments add complexity in portfolio management for LPs.
In summary, co-investment funds allow limited partners to invest alongside private equity funds in individual deals. They provide opportunities for superior returns but also pose unique risks that must be managed.