The Rise of Co-Investments

What has led to the rise in co-investments, and are they here to stay?

In recent years, the trend of co-investing has gained increased traction as General Partners (GPs) continually innovate mechanisms to secure capital while Limited Partners (LPs) endeavor to optimize returns and attenuate fees. The increased cost of debt has also contributed to the popularity. GPs are looking to structure deals with less leverage that they have previously been able to in a low interest environment and therefore seek larger equity contributions to fund buyouts. LPs provide a friendly source of capital when presented with co-investment opportunities.

These strategies remain a noteworthy consideration for both GPs and LPs in 2024, given their distinctive potential advantages and the unique attributes that lend themselves to the current fundraising market.

The benefits of co-investing for LPs encapsulate several key aspects:

• Direct Access and Exposure Management: Traditional fund-of-funds vehicles distribute investments across numerous portfolio entities; co-investment practices provide a contrast to this approach. LPs gain the opportunity for more direct returns from specific portfolio companies. This strategy, deployed in concurrence with various GPs, adequately preserves diversification while allowing the LP greater control in crafting their portfolio to regulate levels of exposure to certain sectors.
• Fee Reduction: With increasing pressure on minimizing fees, co-investment serves as a strategy to maintain equity investment levels without the corresponding fee burden typical of a conventional private equity fund.
• Pace of Deployment: Conventional co-mingled private equity vehicles often involve an extended capital deployment timeline over several years. Co-investment provides LPs with the capability to control their capital deployment, somewhat mitigating the heightened prominence of the J-curve effect in recent time times.
• Due Diligence Accessibility: Co-investment vehicles offer LPs an opportunity to evaluate GPs' investment processes, affording them greater control and transparency not typically afforded in traditional arrangements. Such proximity offers potential benefits to GPs as well, as further detailed below.

There are also significant benefits for GPs, including:

• Capital Access: By diversifying offerings beyond traditional mechanisms, GPs can sustain capital levels, despite the current fundraising challenges across the industry.
• Fundraising Pace: Preqin data indicates that the average fundraising duration for a co-investment fund is approximately eight months, significantly less than the average 22-month period for private equity overall¹.
• Relationship Cultivation: Facilitating select LPs with exclusive investment opportunities and insight into the GPs' internal processes can foster deeper relationships, enhancing the probability of continued investment in subsequent capital raises.

This strategy, nevertheless, is not devoid of its own challenges, necessitating the establishment of clear relationship parameters from the outset. For example, while some LPs may prefer a relatively passive stance, others might seize co-investment as an opportunity for enhanced influence. For GPs, the potential for relationship development with co-investing LPs exists, but at the risk of potentially alienating other LPs who might perceive this as favoritism and offering an unfair advantage.

In addition, co-investments continue to outperform investments into traditional private equity structures on a global basis, as demonstrated by Preqin's quarterly index return data, shown below.