What Is an Equity Co-Investment?
An equity co-investment is aminority investment in a company made by investors alongside a private equityfund manager or venture capital (VC) firm. Equity co-investment enables other investors to participate in potentially highly profitable investments without paying the usual high fees charged by aprivate equity fund.
Equity co-investment opportunities are typically restricted to large institutional investors who already have an existing relationshipwith the private equity fund managerand are oftennot available to smaller or retail investors.
Key Takeaways
- Equity co-investments are relatively smaller investments made in a company concurrent with larger investments by a private equity or VC fund.
- Co-investors are typically charged a reduced fee, or no fee, for the investment and receive ownership privileges equal to the percentage of their investment.
- They offer benefits to the larger funds in the form of increased capital and reduced risk while investors benefit by diversifying their portfolio and establishing relationships with senior private equity professionals.
Understanding Equity Co-Investments
According toa study by Preqin, 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 sponsororgeneral partner (GP) with whom the investor has a well-defined private equity partnership. The partnership agreement outlineshow the GP allocates capital anddiversifies 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
In 2018, consulting firm McKinsey stated that the value of co-investment deals has more than doubled to $104 billion since 2012. The number of LPs making co-investments in PE rose from 42 percent to 55 percent in the last five years. But direct investing LPs grew by only one percent from 30 percent to 31 percent during the same period.
Why would a private equity fund manager give away a lucrative opportunity? Private equity is usually invested through anLPvehicle 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 Axial, an equity raising platform, almost 80% of LPs prefersmall to mid-market buyout strategies and $2 to $10 million per co-investment. In simple words, this means that they prefer to focus on less flashy companies with expertise in a niche area as opposed to chasing high-profile company investments. Almost 50% ofsponsors 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 totraditional fund investments. Consulting firm PwC states that 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 LPspay 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 ofCo-Investments for General Partners
At first glance, it would seem that GPs lose on fee income and relinquish some control of the fund through co-investments. However,GPs can avoid capital exposure limitations or diversification requirements by offering a co-investment.
For example, a $500 millionfund 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 millionfor each company.If a new opportunity merged with an enterprise value at $350, the GP would need to seekfunding outside its fund structure because it canonly invest $100 milliondirectly. The GP couldborrow $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 has its advantages, co-investors in such deals should read the fine print before agreeing to them.
The most important aspect of such deals is the absence of fee transparency. Private equity firms do not offer much detail about the fees they charge LPs. In cases like co-investing, where they purportedly offer no-fee services to invest in large deals, there might be hidden costs. For example, they may charge monitoring fees, amounting to several million dollars, that may not be evident at first glance from LPs.
There is also the possibility that PE firms may receive payments from companies in their portfolio to promote the deals. Such deals are also risky for co-investors because they have no say in selecting or structuring the deal. Essentially, the success (or failure) of the deals rests on the acumen of private equity professionals that are in charge. In some cases, that may not always be optimal as the deal may sink.
One such example is the case of Brazilian data center company Aceco T1. Private equity firm KKR Co. acquired the company in 2014 along with co-investors, Singaporean investment firm GIC and the Teacher Retirement System of Texas. The company was found to have cooked its books since 2012 and KKR wrote down its investment in the company to zero in 2017.
FAQs
An equity co-investment (or co-investment) is a minority investment made by the co-investor into a company. The investment is made alongside a financial sponsor. An example of a co-investor includes institutional investors such as an insurance company, pension fund, or endowment.
What are the benefits of equity investment? ›
One of the benefits of investing in equity is that it offers returns in not just one, but two forms — capital appreciation and dividend income. A dividend is a distribution of surplus profits by a company to its shareholders. Dividend income is essentially an additional income to the investor.
What are the benefits of co-investment? ›
Co-investments can help LPs to control deployment pace as well as increase exposure to certain GPs, geographies, market segments, or sectors. A third benefit is that co-investing provides a better understanding of the GP's sourcing and due diligence process and can help to create or or strengthen a relationship.
What is co invest equity? ›
Equity co-investments are relatively smaller investments made in a company concurrent with larger investments by a private equity or VC fund. Co-investors are typically charged a reduced fee, or no fee, for the investment and receive ownership privileges equal to the percentage of their investment.
How do private equity co-investments work and what are they used for? ›
In a typical private equity co-investment, investors can inject capital into profitable assets alongside private equity fund managers. However, private equity firms typically open up these opportunities to large institutional investors with whom they have relationships.
How does equity work as a benefit? ›
Equity compensation allows the employees of the firm to share in the profits via appreciation and can encourage retention, particularly if there are vesting requirements.
How do equity investments work? ›
An equity investment is money that is invested in a company by purchasing shares of that company in the stock market. These shares are typically traded on a stock exchange.
What is an example of a co-investment? ›
An example of a co-investor includes institutional investors such as an insurance company, pension fund, or endowment. The term minority investment means the co-investor owns less than 50% of the portfolio company.
What are co-investment rights? ›
Summary. This co-investment rights clause for a private equity fund (PEF) side letter is to be used when the PEF grants an investor the right to participate in investments made outside of the PEF. Without this provision, an investor will usually have no right to be offered such investment opportunities.
Why are co investments attractive? ›
Co-investing offers sophisticated institutional and high net-worth investors the opportunity to gain greater exposure to attractive assets but at lower fees—thus squeezing out fatter returns.
An equity-linked investment (ELI) is a type of structured product. Its investment return is directly linked to the performance of a single underlying equity or a basket of up to 4 underlying equities. An ELI is typically a short to medium-term investment product that may provide potential yield enhancement.
What is the difference between investment and co-investment? ›
These methods are: Fund Investment: This is the first method where investors put their money into a fund, such as a Private Equity (PE) fund. For instance, an investor might choose to invest in the Blackstone Group, a well-known PE fund. Co-Investment: In this method, the investor invests in a fund's portfolio company.
What is the co-investment approach? ›
This method involves investing in a “sidecar” vehicle alongside a main private equity fund, managed by the same GP. This allows you to take an additional stake in certain portfolio companies on top of an allocation to the main fund.
How do private equity investors get paid? ›
Private equity firms buy companies and overhaul them to earn a profit when the business is sold again. Capital for the acquisitions comes from outside investors in the private equity funds the firms establish and manage, usually supplemented by debt.
What are the challenges of co-investment? ›
While co-investments offer significant benefits, they also come with their own set of challenges and risks. One key challenge is the need for a high level of expertise and due diligence. Co-investors must be able to evaluate potential investments, negotiate deal terms and manage their investments post-acquisition.
Why do people invest in private equity? ›
The underlying reason for private equity investing is to achieve returns on investment that may not be achievable in the public market. Partners at PE firms raise and manage funds to yield favorable returns for shareholders, typically with an investment horizon of four to seven years.
What are the advantages of equity method investment? ›
Equity Method provides a better understanding of the financial health of the investee company. By having access to the investee's financial statements, the investor can analyze the company's performance and make informed decisions about their investment.
What is the main advantage of equity? ›
The main advantage of equity financing is that there is no obligation to repay the money acquired through it. Equity financing places no additional financial burden on the company, however, the downside can be quite large.
What are the pros and cons of equities? ›
Investing in stocks offers the potential for substantial returns, income through dividends and portfolio diversification. However, it also comes with risks, including market volatility, tax bills as well as the need for time and expertise.
What are two benefits of equity? ›
There are many advantages of equity financing, including:
- There is no obligation to repay the money.
- There are no additional financial burdens on the company – since there are no required monthly payments the company has more capital available to invest in growing their business.
