Private equity co-investments have become an increasingly important trend in recent years. As private equity funds seek to deploy more capital and limited partners aim to enhance returns, co-investments provide benefits to both groups. Key factors driving greater co-investment activity include high asset valuations requiring more equity, LP desire for lower fees and greater control, and PE fund mandates to facilitate co-investments. Going forward, co-investments are expected to continue growing as a proportion of overall private equity investment. LPs and GPs will focus on enhanced collaboration and transparency around deals. Emerging managers and retailing of smaller deals will also shape industry evolution.
High asset valuations requiring more equity capital
With private equity purchase price multiples reaching record levels in recent years, equity contributions have had to increase substantially to fund deals. Average equity contributions have risen from around 30% historically to 40-50% today. This has led PE firms to bring more outside capital via co-investments to meet equity needs. As asset valuations stay elevated, co-investment will remain instrumental in closing larger deals.
LP desire for lower fees and more control
Limited partners have become increasingly interested in co-investments as a way to gain greater visibility and control in deals as well as reduce the typical 2/20 fee structure of private equity funds. By co-investing, LPs earn additional spread between the cost of capital and ultimate returns while avoiding management fees and carry. The ability to have input on governance and exit decisions is also valued highly by LPs.
PE mandates to facilitate co-investment
As LPs allocate more capital to private equity, they are negotiating terms that obligate GPs to provide co-investment opportunities in fund portfolios. These mandated co-investment amounts have been steadily rising, requiring PE firms to have dedicated teams and infrastructure to source third-party capital for deals. This alignment of interest between LPs and GPs will further propel co-investing as standard practice going forward.
Outlook for greater information sharing and emerging manager focus
The private equity industry still faces calls from LPs for greater transparency and information sharing around co-investments. While due diligence materials are typically provided, there is room to improve reporting and clarity on valuation methodologies, fee waivers, and governance. Additionally, NASDAQ estimates that nearly 50% of co-investments are related to add-on acquisitions to existing portfolio companies, indicating opportunity for emerging managers or retail investors to participate in more platform company investments.
In summary, private equity co-investments are becoming more prevalent due to necessity on the part of GPs and strong LP demand. Current industry dynamics point to the continuation of this trend as deal sizes increase, relationships deepen between LPs and GPs, and avenues widen for participation across the investor spectrum.