Understanding Equity Co-Investment and Its Benefits

Equity co-investment is a way for investors to partner with venture capital firms or other experienced investors to invest in a company. This approach can provide access to deals that might not be available otherwise.

By co-investing, you can gain a seat at the table and participate in the decision-making process. This can be especially beneficial for smaller investors or those new to the space.

Equity co-investment can also provide a way to diversify your portfolio and reduce risk. By investing alongside experienced partners, you can tap into their expertise and network.

Co-investing can also lead to better returns, as you're sharing the risk with a partner who has a deeper understanding of the investment.

Co-investing provides various benefits for investors, including lower fees and improved net returns.

Co-investments offer several potential benefits, such as accelerated capital deployment and diversification.

By co-investing, you can control industry sector and geographic exposures directly, which is more limited in primary private equity investing.

This can be especially beneficial for investors who want to tailor their investment strategy to their specific needs.

Co-investing can also help you access attractive deals and benefit from the expertise and deal-sourcing capabilities of private equity firms.

Opening up opportunities for Limited Partners (LPs) to invest in lucrative deals can increase the capital invested in these companies, boosting profit margins.

Co-investing creates more opportunities to invest in different markets or sectors, which expands the overall net return on various asset classes.

Co-investments require quicker decision making than fund investments, so it's essential to have dedicated resources and efficient approval processes in place to support unpredictable workloads and rapid transaction timelines.

Our systematic co-investment due diligence and decision-making process incorporates broader members of our global private markets investment team to provide the appropriate experience for evaluating co-investment opportunities across strategies and geographies.

Co-investors are typically institutional or high-net-worth investors who make their investments alongside private equity or venture capital firms, and they are usually charged a reduced fee for the investment.

In a typical private equity co-investment, investors can inject capital into profitable assets alongside private equity fund managers, and both parties stand to benefit from the success of the co-investment.

Here are the key factors to consider when implementing a co-investment strategy:

To mitigate adverse selection, it's essential to thoroughly evaluate the deal and GP fit, and to be responsive and transparent in your relationship with the GP.

Participation in co-investments requires LPs to remain fully aware of the risks, mostly related to the specifics of each co-investment.

LPs often rely on the expertise and due diligence of the private equity firms offering the co-investment opportunity, which can be challenging if the deal is moving quickly.

There's also heightened demand for specialized skills to effectively manage co-investments, making it essential for GPs or LPs to adopt these skill sets internally to compete favorably when sourcing deals.

Co-investing creates competition among investors, reinforcing the need for GPs to nurture relationships with high-quality LPs.

Participating in co-investments requires LPs to stay fully aware of the risks involved, which are often related to the specifics of each co-investment.

GPs may not always provide sufficient transparency, making it challenging for LPs to track the history and particulars of the deal.

LPs often rely on the expertise and due diligence of the private equity firms offering the co-investment opportunity.

If a deal is moving quickly, there may be insufficient time for an LP to conduct due diligence, which can impact the investment later in its lifecycle.

GPs or LPs without specialized skills to manage co-investments may struggle to identify opportunities that yield returns.

This creates competition among investors, reinforcing the need for GPs to nurture relationships with high-quality LPs.

Investors must be cautious of adverse selection, where they "double down" on exposures they already have through their fund commitment.

To reduce the risk of adverse selection, investors should review a GP's co-investment track record and the deal's match to the GP's strategy.

Co-investment opportunities can lower the risk of LPs losing money through widespread fund-of-fund investments.

By co-investing with reputable private equity firms, LPs can control the risk of losses since the GP drives most of the deal sourcing and due diligence to de-risk the investment.

This approach gives investors more control over investment decision-making, which can lower risk to a certain extent and increase their involvement in determining an asset's growth.

Co-investment allows LPs to participate directly in investment decisions, reducing their reliance on the GP's decision-making process.

This increased involvement can also lead to more informed investment choices, further mitigating risk.

Co-investment opportunities can provide a more balanced risk profile for LPs, as they are not solely reliant on the performance of a single fund.

Investors should be aware that co-investing is a multi-faceted discipline, and there are many aspects to consider. Co-investment portfolios require active monitoring and responsive LPs to avoid GP-LP relations from fraying.

The level of due diligence information and ongoing monitoring provided by GPs varies enormously, and investors should avoid co-investing with GPs unwilling to provide sufficient due diligence materials and quarterly reporting beyond simple capital statements.

Investors should also consider the potential risks and considerations that differ from private market fund investing, such as lower fees, improved net returns, accelerated capital deployment, and diversification. A strategic allocation to co-investments, set at 15% to 30% of an investor's total allocation to private investments, can help maximize benefits.

Here are some key factors to consider when setting an allocation target to co-investments:

Setting a strategic allocation to co-investments can be a good idea, as it allows for tactical flexibility since co-investments are inherently opportunistic in nature. Consider setting a target range to accommodate this flexibility.

Co-investing is an active discipline that requires responsive and transparent investors. This helps strengthen the relationship with and deepen understanding of the GP.

LPs can participate in processes like choosing how funds are invested during the deal, but GPs primarily drive the co-investment deal and involve LPs as a source of supplementary capital.

Investors should focus on finding a partner capable of accessing a robust deal flow and constructing a co-investment portfolio that is concentrated in best ideas from high conviction managers without being overdiversified.

Mercer advises that past investment performance is not an indication of future results and that there is always the possibility of loss when investing.

Investors should be aware of the potential for adverse selection, which can be mitigated by thorough evaluation of the deal and GP fit.

A co-investment manager can be appointed to help investors access a robust deal flow and construct a co-investment portfolio.

Investors should consider aggregating all co-investments into a single line item to maintain focus on the program and avoid distractions.

Investors should be upfront about their expectations for due diligence information and ongoing monitoring from GPs.

Tax optimization is a significant benefit of co-investment arrangements, allowing investors to plan around tax-related concerns.

Having extensive information about the asset or company ahead of time helps co-investors successfully plan for audits and reports.

This proactive approach helps avoid surprises down the line, which can be costly and time-consuming to resolve.

Investors can use this information to make informed decisions about their investments and minimize potential tax liabilities.

By planning ahead, co-investors can ensure they are in compliance with tax regulations and avoid any potential penalties or fines.

Implementation Approaches can be a challenge for investors, but understanding the different options can help. Investors with large Private Investment (PI) portfolios over $1 billion in net asset value (NAV) have a sufficient number of General Partner (GP) relationships and are likely significant Limited Partners (LPs) in funds, which can make it easier to source co-investment opportunities.

Investors with medium-sized PI portfolios between $200 million and $1 billion in NAV may struggle to source sufficient co-investment opportunities, especially if they lack the capability to evaluate co-investments within their team or cannot spare human capital.

Investors with PI portfolios below $200 million in NAV will find it difficult to source sufficient co-investment deal flow, and it's less work for GPs to fill a co-investment allocation with two to three large LPs than ten smaller ones.

To overcome these challenges, investors can consider partnering with a specialist co-investment manager to augment deal flow and provide vetted opportunities. This can be particularly beneficial for investors with smaller PI portfolios who lack the internal capabilities to oversee a co-investment program.

For investors with smaller PI portfolios, making a commitment to an externally managed, commingled co-investment fund can provide access to a diversified roster of sector specialists and/or managers targeting the middle- and lower-middle-market space at a lower fee base.

Here are some key considerations for investors looking to implement a co-investment strategy:

Co-investment is becoming popular because it allows investors to inject capital directly into a deal without the complexities of limited partnerships, where they have diminished control over investment decisions.

Private equity co-investments typically involve injecting capital into profitable assets alongside private equity fund managers. These opportunities are often reserved for large institutional investors with whom private equity firms have established relationships.

Private equity firms handpick individual investments, providing co-investors with greater visibility into what each deal might look like in the long term.

Both parties in a co-investment stand to benefit from the success of the deal, with the private equity firm adding an asset to its portfolio and the co-investor sharing in the profit gained from the opportunity.

Investors can set a strategic allocation to co-investments, representing 15% to 30% of their total allocation to private investments.

To maximize the benefits of co-investing, individual co-investments should be sized to have a meaningful positive impact, but not to disrupt the portfolio in case of underperformance.

A fraction of a typical fund commitment, around 25%, is a good rule of thumb to start.

An investment is essentially a way to put your money into something that has the potential to grow in value over time.

Equity co-investments, for instance, are minority investments made by investors alongside private equity fund managers or venture capital firms.

These investments can be highly profitable, but they often come with high fees charged by the private equity fund.

Large institutional investors typically have access to these opportunities through their relationships with private equity fund managers.

Smaller or retail investors usually don't have the same level of access to these investments.

Equity co-investments can be a powerful tool for investors, but it's essential to set the right policy to maximize benefits. To start, investors should set an allocation target to co-investments in their investment policy statement, which can take the form of a dedicated strategic allocation or a more tactical one.

Investors should aim to allocate 15% to 30% of their total allocation to private investments towards co-investments. Individual co-investments should be sized to have a meaningful positive impact if they meet underwriting targets, but not to disrupt the portfolio in case of underperformance.

A fraction of a typical fund commitment is a good rule of thumb to start, around 25%. This will help maintain a steady and consistent pacing of co-investments to ensure diversification and exposure.

Co-investments require relationship-building and nurturing to enable long-term collaboration between GPs and LPs. Notable strategies worth knowing include setting a range for co-investments to retain tactical flexibility.

By opening up opportunities for LPs to invest in lucrative deals, GPs can increase the capital they invest in these companies, boosting profit margins.

Allvue Systems has built a private equity software solution that helps investors manage their investments, source and execute deals effectively, and raise capital quickly.

This solution automates cumbersome tasks and helps General Partners (GPs) and Limited Partners (LPs) navigate complex transactions.

Private equity firms must remain adaptable and build relationships with their limited partners to keep capital coming in to fund potential deals.

Allvue's software streamlines the path to success for co-investment arrangements, making it easier for GPs and LPs to stay ahead of the competition.

By using data-driven tools and business intelligence, private equity fund managers can make quick turnarounds of investment decisions and identify high-value opportunities.

Allvue's private equity software solution is handy for co-investment arrangements, helping investors navigate complex transactions and make informed decisions.