Co-investment refers to the direct investment activity in a project jointly participated by the general partner (GP) and the limited partner (LP) in the field of private equity investment. It allows LPs to invest alongside an existing GP in specific companies on negotiated terms. Co-investments are attractive to LPs because they provide economics superior to those achieved solely from fund investments and allow LPs to selectively increase exposure to portfolio companies about which they have conviction. For GPs, co-investments can provide access to additional capital without the responsibility of ongoing fundraising and allow flexibility around ownership limits. This article will analyze the definition, characteristics, motivations, challenges and recommendations of co-investments.
Co-investment provides economics superior to fund investment for LPs
The returns of co-investments are often higher than fund investments for LPs. According to Preqin’s survey, 80% of LPs have achieved better returns from co-investments compared to regular fund investments. Among them, 46% of LPs have obtained over 5.1% higher returns from co-investments. In addition, LPs can save management fees and carry in co-investments. According to Mckinsey, 49% of GPs charge no fees and 48% charge no carry for co-investments. The savings in costs directly translate into extra returns.
Co-investment allows LPs to selectively increase exposure with conviction
Co-investment provides LPs the flexibility to selectively invest in specific deals they have high conviction in, instead of blindly investing in a whole fund. It allows LPs to target attractive sectors or geographies and build a customized portfolio. LPs can also leverage the sourcing and due diligence capabilities of their GP partners in co-investments.
Co-investment provides additional capital for GPs without fundraising
For GPs, co-investments provide additional capital for deals without ongoing fundraising responsibilities. It also allows them to get around fund investment limits and ownership restrictions. Offering co-investment opportunities can strengthen LP relationships and LP confidence in deploying capital into future funds. However, GPs need to be careful not to adversely select subpar deals for co-investments.
Major challenges of co-investments include lack of deals, capabilities and quick decision-making
Although attractive, co-investments also pose major challenges to LPs. The lack of quality deal flow is the top barrier for LPs’ participation. LPs need to proactively strengthen relationships with GPs and demonstrate their value-add to gain access to the best co-investment opportunities. Besides, LPs need to have strong investment capabilities and a quick decision-making process to conduct due diligence and make investment decisions within 1-3 weeks, otherwise they risk losing co-investment opportunities and GP’s confidence in future partnerships.
In conclusion, co-investment provides superior returns for LPs and additional capital for GPs, but also requires LPs to have extensive sourcing networks, investment capabilities and an efficient decision-making mechanism in place. When done right, it can benefit both LPs and GPs.