Equity Co-Investment

What Is an Equity Co-Investment?

An equity co-investment is a minority investment in a company made by investors alongside a private equity fund manager or venture capital (VC) firm. Equity co-investment empowers different investors to take part in possibly highly beneficial investments without paying the standard high fees charged by a private equity fund.

Equity co-investment opportunities are normally restricted to large institutional investors who as of now have an existing relationship with the private equity fund manager and are frequently not accessible to more modest or retail investors.

Grasping Equity Co-Investments

According to a study by Preqin, 80% of LPs reported better performance from equity co-investments compared to traditional fund structures. In a normal co-investment fund, the investor pays a fund support or general partner (GP) with whom the investor has a clear cut private equity partnership. The partnership agreement frames how the GP designates capital and enhances assets. Co-investments keep away from normal limited partnership (LP) and general (GP) funds by investing directly in a company.

Why Limited Partners Want More Co-Investments

In 2018, consulting firm McKinsey stated that the value of co-investment deals has dramatically increased to $104 billion starting around 2012. The number of LPs making co-investments in PE rose from 42 percent to 55 percent in the last five years. However, direct investing LPs developed by just a single percent from 30 percent to 31 percent during a similar period.

How could a private equity fund manager offer away a lucrative chance? Private equity is typically invested through a LP vehicle in a portfolio of companies. In certain circumstances, the LP's funds may as of now be completely committed to a number of companies, and that means that assuming that another prime opportunity arises, the private equity fund manager may either need to miss the opportunity or offer it to certain investors as an equity co-investment.

According to Axial, an equity raising platform, practically 80% of LPs favor little to mid-market buyout strategies and $2 to $10 million per co-investment. In simple words, this means that they like to zero in on less showy companies with expertise in a niche area rather than chasing high-profile company investments. Practically half of supporters charged no management fee on co-investments in 2015.

Equity co-investment has accounted for a lot of recent growth in private equity fundraising since the financial crisis compared to traditional fund investments. Consulting firm PwC states that LPs are progressively seeking co-investment opportunities while haggling new fund agreements with advisers since there is greater deal selectivity and greater potential for higher returns.

Most LPs pay a 2% management fee and 20% carried interest to the fund manager who is the GP while co-investors benefit from lower fees or no fees at times, which helps their returns.

The Attraction of Co-Investments for General Partners

From the outset, apparently GPs lose on fee income and surrender some control of the fund through co-investments. Nonetheless, GPs can stay away from capital exposure limitations or diversification requirements by offering a co-investment.

For instance, a $500 million fund could choose three enterprises valued at $300 million. The partnership agreement could limit fund investments to $100 million, which would mean the firms would be leveraged by $200 million for each company. On the off chance that another opportunity merged with an enterprise value at $350, the GP would have to look for funding outside its fund structure since it can invest $100 million directly. The GP could get $100 million for financing and offer co-investment opportunities to existing LPs or outside parties.

The Nuances of Co-Investments

While co-investing in private equity deals enjoys its benefits, co-investors in such deals ought to peruse the fine print before consenting to them.

The main aspect of such deals is the shortfall of fee transparency. Private equity firms don't offer a lot of insight regarding the fees they charge LPs. In cases like co-investing, where they purportedly offer no-fee services to invest in large deals, there may be hidden costs. For instance, they might charge monitoring fees, amounting to several million dollars, that may not be clear right away from LPs.

There is additionally the possibility that PE firms might receive payments from companies in their portfolio to advance the deals. Such deals are likewise risky for co-investors since they have nothing to do with choosing or organizing the deal. Basically, the achievement (or disappointment) of the deals lays on the astuteness of private equity experts that are in charge. At times, that may not generally be optimal as the deal might sink.

One such model is the case of Brazilian data center company Aceco T1. Private equity firm KKR Co. acquired the company in 2014 alongside co-investors, Singaporean investment firm GIC and the Teacher Retirement System of Texas. The company was found to have cooked its books starting around 2012 and KKR recorded its investment in the company to zero of every 2017.

Highlights

• Equity co-investments are generally more modest investments made in a company concurrent with larger investments by a private equity or VC fund.
• They offer benefits to the larger funds as increased capital and decreased risk while investors benefit by enhancing their portfolio and laying out associations with senior private equity experts.
• Co-investors are regularly charged a decreased fee, or no fee, for the investment and receive ownership privileges equivalent to the percentage of their investment.