Equity Co-Investment

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What is ‘Equity Co-Investment’?

Equity co-investment is a minority investment in a company made by investors alongside a private equity fund manager or venture capital firm. Equity co-investment enables investors to participate in potentially highly profitable investments without paying the usual fees charged by a private equity fund. Equity co-investment opportunities are typically restricted to large institutional investors who already have an existing relationship with the private equity fund manager and are typically not available to smaller or retail investors.

BREAKING DOWN ‘Equity Co-Investment’

According to a study from ValueWalk, 80% of LPs reported better performance from equity co-investments compared to traditional fund structures. In a typical co-investment fund, the investor pays a fund sponsor, or general partner (GP) with whom the investor has a well-defined private equity partnership. The partnership agreement outlines how the GP allocates capital and diversifies assets. Co-investments avoid typical limited partnership  (LP) and general (GP) funds by investing directly in a company. 

Why Limited Partners Want More Co-Investments

Why would a private equity fund manager give away a lucrative opportunity? Private equity is usually invested through an LP vehicle in a portfolio of companies. In certain situations, the LP’s funds may already be fully committed to a number of companies, which means that if another prime opportunity emerges, the private equity fund manager may either have to pass up the opportunity or offer it to some investors as an equity co-investment.  

According to ValueWalk, almost 80% of LPs prefer small to mid-market buyout strategies and $2 to 10 million per co-investment. Almost 50% of sponsors did not charge any management fee on co-investments in 2015. 

Equity co-investment has accounted for a significant amount of recent growth in private equity fundraising since the financial crisis compared to traditional fund investments. LPs are increasingly seeking co-investment opportunities when negotiating new fund agreements with advisers because 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 in some cases, which boosts their returns.

The Attraction of Co-Investments for General Partners

Axial, an equity raising platform explains why a general partner (GP) would offer a co-investment? GPs lose would seem to lose on fee income and relinquish some control of the fund. However, GPs can avoid capital exposure limitations or diversification requirements by offering a co-investment. For example, a $500 million fund could select three enterprises valued at $300 million. The partnership agreement might limit fund investments to $100 million, which would mean the firms would be leveraged by $200 million for each company. If a new opportunity merged with an enterprise value at $350, the GP would need to seek funding outside its fund structure because it can only invest $100 million directly. The GP could borrow $100 million for financing and offer co-investment opportunities to existing LPs or outside parties.